Risk Transfer by Surety Bonds . ...... contractor and subcontractor to sureties or guarantors. ...... A surety bond is not an insurance policy; it is the contract that.
PROJECT RISK MANAGEMENT
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Table of Contents INTRODUCTION ................................................................................................ 5
WHAT IS RISK? .............................................................................5 Common Risks Affecting Estimate .............................................................. 6
Project Risk Management ...............................................................8 When is project risk management used? .....................................9 Risk Management Framework .....................................................11 Stakeholder identification and analysis .......................................12 Differences In Personal Risk Attitude ........................................................ 16
Plan Risk Management .................................................................17 Planning meetings & analysis ..................................................................... 17 Risk management plan ................................................................................ 17 RISK IDENTIFICATION .................................................................................. 21 Identification participants ........................................................................... 21 Information gathering techniques ............................................................... 22 Other identification techniques ................................................................... 27
Risk Register...................................................................................28 Risk Documentation ......................................................................29 Risk Responsibility ........................................................................30 Information Source ........................................................................30 Risk Allocation in Contracting .....................................................31 Known and Unknown Risks in Contracts ................................................... 32
Financial Risks ...............................................................................34 Types of Financial Risks ............................................................................. 34 Financial Risk in Concession Contracts ..................................................... 36 Global and Elemental Risks In Concession Contracts ............................... 37 QUALITATIVE ANALYSIS ............................................................................. 40 Qualitative Risk Assessment....................................................................... 40 Review of Project Programs and Budgets .................................................. 40 1
The Risk Log/Register ................................................................................ 42
Qualitative Methodologies ............................................................42 Risk probability & impact assessment ........................................................ 43 Probability ................................................................................................... 43 Impact.......................................................................................................... 43 Risk Probability and Impact........................................................................ 44
Risk Evaluation ..............................................................................47 Inherent risk ................................................................................................ 47 Risk data quality assessment ....................................................................... 47 Risk urgency assessment............................................................................. 48 RISK QUANTIFICATION ................................................................................ 50
Risk Quantitative Analysis............................................................51 General Approach..........................................................................52 Application......................................................................................54 Utility Theory .............................................................................................. 56
Perform Quantitative Risk Management ....................................58 Data gathering & representation techniques ............................................... 58
SENSITIVITY ANALYSIS ..........................................................59 EXPECTED MONETARY VALUE............................................62 Decision tree ............................................................................................... 65
SIMULATION ...............................................................................68 THE RISK PREMIUM .................................................................76 RISK-ADJUSTED DISCOUNT RATE .......................................77 DECISION ANALYSIS ................................................................78 CERTAINTY, RISK, AND UNCERTAINTY ............................79 Decision Making Under Certainty .............................................................. 79 Decision Making Under Risk...................................................................... 79 Decision Making Under Uncertainty .......................................................... 81
SCENARIO ANALYSIS ...............................................................85 RISK RESPONSE............................................................................................... 86 2
Strategies for Negative Risks or Threats .....................................87 Avoidance ................................................................................................... 87 Mitigation .................................................................................................... 89 Transference ................................................................................................ 91 Acceptance .................................................................................................. 93
Strategies for Positive Risks or Opportunities............................95 Exploit ......................................................................................................... 98 Share............................................................................................................ 98 Enhance ....................................................................................................... 98 Contingent response strategies.................................................................... 98 Contractual Risk Allocation Strategies ..................................................... 100 Risk Allocation According to Payment Mechanism ................................ 104 Outsourcing ............................................................................................... 106
Contract Award ...........................................................................108 Contractual Sharing In Governmental Projects ........................................ 108
The Fundamental Risks-Liability and Responsibility .............111 Risk Transfer by Surety Bonds ................................................................. 111
Risk Action Plan ...........................................................................115 Managing medium risks ........................................................................... 117
Determining Contingency ...........................................................118 Mak and Picken Model ............................................................................. 119 Contingency Management Model by Ford ............................................... 121
BOT Projects Risk Assessment ..................................................124 Zayed and Chang Model ........................................................................... 124 Risk in BOT Projects ................................................................................ 126 Political Risks in BOT Projects ................................................................ 127 Risk Reduction in BOT Projects ............................................................... 129
Exchange Rate Risk Management .............................................131 Tactics and Strategies for Reducing Foreign Exchange Risk................... 131 Reducing Economic Exposure .................................................................. 132 3
Developing Policies for Managing Foreign Exchange Exposure ............. 132 RISK MONITORING ....................................................................................... 134 RISK CONTROL .............................................................................................. 135
Communication and reporting ...................................................137 Risk Management of International Projects .............................139 Occupational Health, Safety and Environment (HSE) ..................................... 142 Hazard and Operability Study (HAZOP).......................................................... 143
........................................................................................................147 Fault Trees......................................................................................................... 148 Benefits of Environmental Risk Management .................................................. 149
Environmental Risk Management .............................................150 Environmental Management Systems ......................................151 Criteria and Consequences ........................................................152 Identification of Environmental Risk ........................................155 Risk Treatment Strategies ..........................................................157 Approaches to Environmental Risk Management ...................157 Appendix A: Risk Aspects ........................................................159 Appendix B: Statistical Measures ..............................................164 Appendix C: Risk Forms.............................................................166 Appendix D: Probabilistic Distributions ...................................170
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INTRODUCTION The construction industry generally has a bad reputation for its work. The industry has a reputation for time and cost overruns. This may be summed up in the commonly held perception that the industry tends to deliver expensive buildings late. Physical l t Material
Similarity
Components Operations Management Structure Management Style
PROJECT B
PROJECT A
Site Condition Structural Loading Conditions Bearing Capacity Size & Location Specs Management Style
Differences
Suppliers & Personnel
Figure 1: Similarities and differences between projects
WHAT IS RISK? The Project Management Institute in their Guidelines for Project Management Body of Knowledge (PMBOK-2008) stated that: Project risk is an uncertain event or condition that, if it occurs, has an effect on at least one project objective. Objectives can include scope, schedule, cost, and quality. A risk may have one or more causes and, if it occurs, it may have one or more impacts. A cause may be a requirement, assumption, constraint, or condition that creates the possibility of negative or positive outcome.
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For example, a cause may be requiring a permit or having limited personnel assigned to the project. The risk event is that the permit may take longer than planned, or the personnel may not be adequate for the task. If either of these uncertain events occurs, there will be a consequence on the project cost, schedule, or quality. Risk conditions could include aspects of the project environment that may contribute to project risk such as poor project management practices, or dependency on external participants that cannot be controlled. Risk arose in the 1940s when it was possible to make a statistical assessment of the probability of occurrence of a particular event. Risk, therefore, tended to be insurable. Using the logic, the actual risk to be carried was quantified as follows (Raftery-1994): Risk = Probability of event X Magnitude of loss/gain
Common Risks Affecting Estimate Technical
Adequacy of site investigation
Availability of materials and components
Adequacy of design and design
information
Logistical
Sourcing materials, plant and labor
Construction
Productivity
Weather
Adequacy of contractor's own construction plan
Adequacy of resource scheduling
Industrial relations
Financial
Escalation/inflation
Payment schedule
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It follows, then, that there will be good reasons for differences in estimates produced by different contractors for the same project. The following are the common types of these differences: Cost of materials
Discounts different suppliers, speed of payment vertical integration
Labor productivity
Skill standard of workmanship
Labor costs
Wages, overtime, good staff
Wastage
Materials, labor, theft
Plant
Amount, type, own/hire
Site techniques
Different sequence of operations
Allowance for fixed price
Future increased costs
Effect of design team Deliberate distortion
Front loading and cash flow, anticipating variations
Overheads Profit
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Project Risk Management The purpose of project risk management is to minimize the risks of not achieving the objectives of the project and the stakeholders with an interest in it, and to identify and take advantage of opportunities. In particular, risk management assists project managers in setting priorities, allocating resources and implementing actions and processes that reduce the risk of the project not achieving its objectives. There are three keys to managing project and procurement risk effectively: 1. identifying, analyzing and assessing risks early and systematically, and developing plans for handling them; 2. allocating responsibility to the party best placed to manage risks, which may involve implementing new practices, procedures or systems or negotiating suitable contractual arrangements; and 3. ensuring that the costs incurred in reducing risks are commensurate with the importance of the project and the risks involved. The scope of risk management for projects includes :. • Business risks include all those risks that might impact on the viability of the enterprise, including market, industry, technology, economic and financial factors, government and political influences. • Project risk includes all those risks that might impact on the cost, schedule or quality of the project. • Operations and processing risks include all those risks that might impact on the design, procurement, construction, commissioning, operations and maintenance activities, including major hazards and catastrophic events.
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When is project risk management used? Many organizations undertake projects involving significant capital outlays, or groups of related projects that together make up large programs. Three aspects of large projects or programs make risk management desirable. • Their size implies there may be large potential losses unless they are managed carefully, and conversely large potential gains if risks are managed well. • They often involve unbalanced cash flows, requiring large initial investments before meaningful returns are obtained. In these circumstances, and particularly for assets with potentially long lives, there may be significant uncertainty about future cash flows, due to changing economic conditions, advances in technology, changing patterns of demand for products or services, new competition, or varying operating requirements. • Large public sector projects may involve a degree of private sector participation, either in the form of direct private sector investment or involvement in the through-life operations of a government-owned asset. For some projects, risk management may be a formal requirement at specific stages of the project development. There may be many reasons for this: • Economic viability assessment, for high-level strategic decision-making about whether or not to proceed with a project; • Financial feasibility assessment, when a finance package is being assembled; • Corporate governance and accountability, for managers, project staff, end-users and suppliers to demonstrate that they have fully assessed all the material risks, that the measures taken to control risk are appropriate, and that the economic reward for taking on the risk that remains is adequate; • Contractual purposes, to assess alternative contractual and legal frameworks for the project, in the context of deciding who should bear what risks and determining an equitable allocation and sharing of risks and rewards between the parties involved; • Tendering, when deciding whether or not to bid, or accept a bid, for a proposed project, and in what form; • Regulatory purposes, for legislative, judicial or licensing agencies, or for public inquiries, to demonstrate accountability in a public or social context; • Communication purposes, to provide information for owners, sponsors, users, contractors, joint venture partners or other stakeholders, or to demonstrate capability and competence in an area. 9
Table 1. Project stages and risk management application examples Project stage Objectives and requirements analysis
Application example Assessment of internal skills needed to assure the success of the process (for example, for procurement of services by outsourcing)
Incentive contract performance and fee modeling Formulation of procurement strategy Development of equipment acquisition strategies Capital evaluation
Capital evaluation of major spending initiatives (some examples from our recent experience include new mine development, IT systems acquisition, infrastructure provision, selection of capital equipment within major developments)
Analysis of options
Exploration of market testing strategies Quantitative analysis of strategic options, with cost and risk tradeoffs Assessment of alternate technologies for major plant upgrades
Board, cabinet or ministerial submissions for approval of major Formulation of proposals for funding projects approval Applications for additional funding Preparation of procurement documents
Detailed development of requests for tender documents that address risks appropriately
Preparation of tender Preparation and assessments of key delivery requirements for tender evaluation plans evaluation plans Evaluation and selection of tenderers
Evaluation of tender submissions taking account of bidders' capacity to manage the risks involved
Review of negotiation priorities ensuring effective risk allocation Negotiation and signature of contracts Implementation and delivery
Implementation and delivery risks, including approvals, technical, construction, budgets, phasing, milestones
Commissioning and handover
Development and management of test and commissioning, transition, delivery
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Risk Management Framework For government procurement, there are likely to be additional requirements that must be addressed and demonstrated explicitly, and may be subject to external audit and oversight. They include: • value for money; • open and effective competition; • ethical behavior and fair dealing; • maximizing opportunities for local industry to compete; • environmental aspects; • quality assurance; • government sanctions against specified countries; • social justice policies. Specific requirements are typically related directly to the project itself. They include such objectives as: • cost control, ensuring the project is conducted within the available budget; • schedule control, ensuring the project is completed within the time frame allowed; • performance quality control, ensuring the project and its outcomes are suitable for their intended purpose.
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Stakeholder identification and analysis Stakeholder analysis is important in risk assessments for most activities. It is usually undertaken at an early stage of planning. All projects and procurements involve at least two stakeholders: the procuring entity (the buyer) and the supplier of goods or services (the seller). The differing objectives of these two parties, and the contractual relationship between them, are key determinants in the allocation and management of risk in the procurement process. Table 2. Stakeholders in a procurement project for a government agency Group Government agency
Stakeholder Executive management Agency business units involved in the procurement process Agency users
Governments and their ministers
National Government Portfolio minister State and local governments
Other government departments
Central funding agencies
Finance providers
Financial institutions and their depositors
Industry
Suppliers of capability
Communities
Local communities and neighbors of a project site Local businesses who benefit directly Local businesses who benefit indirectly
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Table 3. Stakeholders in a private sector project Group Senior management
Stakeholder Major shareholders The board Executive management team
Business units with an Sponsoring business units, including users Engineering function interest in the project Maintenance function Other users Administrative and support functions Staff
Operators Maintainers Contractors
Industry
Suppliers and service providers Commercial counterparts
Purchasers and users of products Shippers
Regulators
Construction and building approvals regulators Occupational health and safety regulators Environmental protection agencies
Community
Public in the local area Wider community outside the local area
Table 4. Stakeholder and issues summary Reference:
Project: Key issues and objectives
Stakeholder
Compiler:
Date:
Reviewer:
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Date:
Table 5. Stakeholder analysis worksheet, public-sector project Stakeholder Executive managers
Desired outcome A capability delivered on schedule, within approved project costs and annual expenditure levels, that meets the endorsed requirements A selected capability acquisition option that demonstrably provides the best value for money
Business units involved in the procurement
A well-structured and efficient procurement strategy Open and effective competition A selected capability acquisition option that demonstrably provides the best value for money
Agency users
A delivered capability that meets the endorsed requirements and the needs of users
Government and ministers
An effective capability for the nation A selected capability acquisition option that demonstrably provides the best value for money Benefits for business and the economy
State and local governments and their ministers
Enhanced opportunities for their local business communities and economies
Central funding agencies
Cost-efficient acquisition of endorsed capabilities An open and accountable acquisition process Budget allocations that are managed efficiently and effectively
Financial institutions
Enhanced business opportunities Effective management of risks associated with the provision of the capital investment A reasonable profit on business investments
Industry
Enhanced business opportunities, sustainable on a long-term basis A delivered capability that meets the needs of users capability Effective management of risks associated with the provision of the capability requirements A reasonable profit on the supply and operation of the capability
Local businesses
Enhanced business opportunities, whether as a prime contractor or sub-contractor A reasonable profit on business activities
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Table 6. Criteria related to objectives for an oil production business Criterion
Objectives
Production loss or restriction
Maximize the value of hydrocarbon resources Increase sustainable production Annual production targets and costs
Facility damage
Minimize disruption to operations; no damage to plant or equipment
Facility integrity
Minimize disruption to operations Maintain asset or system condition and performance
Project performance
Cost-effective strategy Operating entities are involved Timely implementation and operation of project facilities Time, cost and performance related to budget
Financial impacts
Supply costs reduced by 10% Capital costs optimized Operating costs improved No losses, no increased or additional costs
Employees
Low turnover, grow skills and experience Health, safety and environmental performance Minimize health, safety and environmental (HSE) risks during construction
Health and safety
Health and safety performance Minimize health and safety risks during construction No injuries, fatalities or long-term health problems
Environment and community
Environment and community performance Minimize environmental and community risks during construction No releases to the environment or public outrage
Image and reputation
Exceptional high performance Shareholder and public support and trust
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Differences In Personal Risk Attitude Biases and misinterpretation occur even in situations where the output from a cost model is reported in ways, which purport to take account of risk exposure. An adviser may state that there is a “reasonable” chance that a project can be completed for less than $40 million. What does this statement actually mean? The language, in itself, seems reasonably clear. However, is a “good” chance a 9 in 10, an 8 in 10, or a 6 in 10? Is a “reasonable” chance an 8 in 10, a 7 in 10, or a 5 in 10? These differences could be very significant to a decision maker choosing between projects or between different approaches to the same project. Estimator’s perspective
Assume that an estimator is just completing work on a bid for a large overseas project. The estimator has to report a net cost estimate to the managing director who will make the mark-up decision. The estimating team gets together on the day before the bid is due to be submitted and decide that their best estimate of the net cost is $72 m. This figure includes tangible and intangible costs, head office overheads, and an allowance for the cost of recovering finance charges. It includes no profit, normal or otherwise. This has been arrived at by breaking the project down. Manager’s perspective
The manager receives this figure together with the background briefing on the project from the estimators and the planning department. The decision on mark-up is a familiar problem to the manager who is accustomed to taking calculated risks in order to secure work at favorable rates for the firm. The manager knows that the estimate is a forecast of the outturn cost should the firm win the project. Thus, for the purposes of calculation, it would be rational to assume that the estimate is the most likely figure drawn from a distribution, which manifests some skewness at the upper end of the range. The mental cost model of the project held in the mind of the manager is that described by the figure. The characteristics of this model are that the most likely outturn cost is $72 m. The optimistic outcome is a project net cost of $65 m, and the pessimistic outcome shows a cost of $86 m.
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Plan Risk Management Planning meetings & analysis The purpose of these meetings, which are held with project team members, stakeholders, functional managers, and others who might have involvement in the risk management process, is to contribute to the risk management plan. During these meetings, the fundamental plans for performing risk management activities will be discussed and determined and then documented in the risk management plan. The key outcomes of performing these planning meetings are as follows:
Risk management plan The risk management plan may include: •
Methodology: This section defines how you will perform risk management for the particular project. Remember to adapt to the needs of each project.
•
Roles and responsibilities: Who will do what? Did you realize that non-team members may have roles and responsibilities regarding risk management?
Risk Responsibility Chart Top management
PM
Management Team
X
X
X
Identify Risk
X
X
Perform Qualitative Risk Management
X
X
X
Perform Qualitative Risk Management
X
X
X
Plan Risk Responses
X
X
X
Monitor & Control Risks
X
X
X
Plan Risk Management
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Risk Owner
•
Budgeting: This section includes the cost for the risk management process.
•
Timing: This sections talks about when to do risk management for this particular project. Risk management should start as soon as you have the appropriate inputs. It should also be repeated throughout the life of the project, since new risks can be identified and may change the degree of risk on the project.
•
Risk categories Project
Technica
Project Managemen t
Organization
Extern
Quality
Time
Objective
Weathe
Performance
Cost
Fund
Labor
Complexity
Resourc
Collaboratio
Politics
Others
Figure 2: Risk categorization Likelihood expectation Level Likelihood
Expected or actual frequency experienced
1
Rare
May only occur in exceptional circumstances; simple process; no previous incidence of non-compliance
2
Unlikely
Could occur at some time; less than 25% chance of occurring; noncomplex process &/or existence of checks and balances
Possible
Might occur at some time; 25 –50% chance of occurring; previous audits/reports indicate non-compliance; complex process with extensive checks & balances; impacting factors outside control of organization
Likely
Will probably occur in most circumstances; 50-75% chance of occurring; complex process with some checks & balances; impacting factors outside control of organization
Almost certain
Can be expected to occur in most circumstances; more than 75% chance of occurring; complex process with minimal checks & balances; impacting factors outside control of organization
3
4
5
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•
Definitions of probably and impact: Would everyone who rates the probability a "five" in qualitative risk analysis mean the same thing? A person who is risk averse might think of seven as very high, someone who is risk prone might think of seven as a low figure. The definitions and the standard probability and impact matrix helps standardize these interpretations and also helps compare risks between projects. Impact scale example Relative or numerical scales Objective
Very low / 0.05
Low / 0.10
Moderate / 0.20
High / 0.40
Very High / 0.80
Cost
Insignificant increase
40% increase
Time
Insignificant increase
20% increase
Scope
Barely noticed change
Minor change
Major change
Unacceptable by sponsor
Product is useless
Quality
Barely noticed
Applications affected
Sponsor approval required
Unacceptable by sponsor
Product is useless
Stakeholder Tolerance Matrix Tolerances Stakeholder
Requirements Time
Cost
Quality
PM
Deliver product as requested
More than More than Conformance 10% Phase II 5% Phase II to all specs
Technical Manager
Passing all QC criteria
More than More than 20% Phase II 10% Phase II
Conformance to all limitations
Marketing Manager
Verify profits
More than More than 5% Phase II 2% Phase II
Customer acceptance
IT Manager
Customer satisfaction (internal & external)
More than More than 20% Phase II 5% Phase II
Positive feedback
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•
Stakeholder tolerances: What if the stakeholders have low risk tolerance for cost overruns? That information would be taken into account to rank cost impacts higher than they would if the low tolerance was in another area. Tolerances should not be implied, but uncovered in project initiating and clarified or refined continually.
•
Reporting formats: This section describes any reports related to risk management that will be used and what they will include.
•
Definitions of terms: (probability, impact, risk types, risk levels, and so on) are developed and documented.
•
The probability and impact matrix is defined or modified for this project. Risk Matrix Consequences
Likelihood
Insignificant
Minor
Moderate
Major
Extreme
Rare
Low
Low
Low
Low
Low
Unlikely
Low
Low
Low
Medium
Medium
Possible
Low
Low
Medium
Medium
Medium
Likely
Low
Medium
Medium
High
High
Almost certain
Low
Medium
Medium
High
Extreme
•
Tracking: Take this to mean how the risk process will be audited, and documenting what happens with risk management activities.
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RISK IDENTIFICATION Identification participants Where time and resources permit, all members of the project team should attend the identification session, including functional unit members assigned to the project on a part-time basis. People who might be included in a brainstorming group are: • the project manager and the project team; • project sponsors and site representatives; • discipline engineers; • experts with specific knowledge in particular areas of concern, where there may be insufficient expertise in the project team; • commercial specialists; • health, safety and environmental specialists; • people with experience in similar previous or current projects; • users of the project outcomes; • key stakeholders who need to be confident in the project and the project management process before approvals are granted.
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Information gathering techniques I.
Documentation reviews: What is and what is not included in the preliminary project scope statement, the project charter and later documents can help identify risks. Lessons learned, articles and other documents can also help uncover risks. Documentation reviews involve reviewing project plans, assumptions, and historical information from a total project perspective as well as at the individual deliverables or activities level. This review helps the project team identify risks associated with the project objectives. Pay attention to the quality of the plans and the consistency between plans.
II.
Brainstorming Brainstorming is a group creativity technique designed to generate a large number of ideas for the solution of a problem. Although brainstorming has become a popular group technique, researchers have not found evidence of its effectiveness for enhancing either quantity or quality of ideas generated. Although traditional brainstorming does not increase the productivity of groups (as measured by the number of ideas generated), it may still provide benefits, such as boosting morale, enhancing work enjoyment, and improving team work. Thus, numerous attempts have been made to improve brainstorming or use more effective variations of the basic technique. There are four basic rules in brainstorming. These are intended to reduce social inhibitions among group members, stimulate idea generation, and increase overall creativity of the group. Focus on quantity: This rule is a means of enhancing divergent production, aiming to facilitate problem solving through the maxim, quantity breeds quality. The assumption is that the greater the number of ideas generated, the greater the chance of producing a radical and effective solution. Withhold criticism: In brainstorming, criticism of ideas generated should be put 'on hold'. Instead, participants should focus on extending or adding to ideas, reserving criticism for a later 'critical stage' of the process. By suspending judgment, participants will feel free to generate unusual ideas. Welcome unusual ideas: To get a good and long list of ideas, unusual ideas are welcomed. They can be generated by looking from new perspectives and suspending assumptions. These new ways of thinking may provide better solutions. Combine and improve ideas: Good ideas may be combined to form a single better good idea, as suggested by the slogan "1+1=3". It is believed to stimulate the building of ideas by a process of association.
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III.
Delphi technique The Delphi method is a systematic, interactive forecasting method which relies on a panel of independent experts. The carefully selected experts answer questionnaires in two or more rounds. After each round, a facilitator provides an anonymous summary of the experts’ forecasts from the previous round as well as the reasons they provided for their judgments. Thus, experts are encouraged to revise their earlier answers in light of the replies of other members of their panel. It is believed that during this process the range of the answers will decrease and the group will converge towards the "correct" answer. Finally, the process is stopped after a pre-defined stop criterion (e.g. number of rounds, achievement of consensus, and stability of results) and the mean or median scores of the final rounds determine the results. This method utilizes a formal Delphi group and is designed to pool the expertise of many professionals in such a way as to gain access to their knowledge and to their technical skills while removing the influences of seniority, hierarchies, and personalities on the derived forecast. The method is named after the oracle at Delphi in ancient Greece.
IV.
Interviewing Interviews are question-and-answer sessions held with others, including other project managers, subject matter experts, stakeholders, customers, the management team, project team members, and users. These people provide possible risks based on their past experiences with similar projects. This technique involves interviewing those people with previous experience on projects similar to yours or those with specialized knowledge or industry expertise. Ask them to tell you about any risks that they’ve experienced or that they think might happen on your project. Show them the WBS and your list of assumptions to help get them started thinking in the right direction.
V.
Root cause analysis Root cause analysis (RCA) is a class of problem solving methods aimed at identifying the root causes of problems or events. The practice of RCA is predicated on the belief that problems are best solved by attempting to correct or eliminate root causes, as opposed to merely addressing the immediately obvious symptoms. By directing corrective measures at root causes, it is hoped that the likelihood of problem recurrence will be minimized.
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However, it is recognized that complete prevention of recurrence by a single intervention is not always possible. Thus, RCA is often considered to be an iterative process, and is frequently viewed as a tool of continuous improvement. VI.
Checklists Checklists are quick to use, and they provide useful guides for areas in which the organization has a depth of experience, particularly for projects that are standard or routine in nature. Sometimes these take the form of standard procedures that have a similar effect. For example, many organizations have checklists for such frequent activities as tendering or contract negotiations, designed to avoid or minimize the risks in those activities. Often, the checklists are part of the organization's quality assurance procedures and documentation. Checklists used during the Risk Identification process are usually developed based on historical information and previous project team experience. . It isn’t possible for a single checklist to be an exhaustive source for all projects. You can improve your checklists at the end of the project by adding the new risks that were identified.
VII.
Diagramming techniques Diagramming techniques, such as system flow charts, cause-and-effect diagrams, and influence diagrams are used to uncover risks that aren't readily apparent in verbal descriptions.
Labor
Productivity
Scope
Delay in Project
Funding
Materials
Manageme
Figure 3: Fishbone (cause and effect) diagram
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1. Cause and effect diagrams - Cause and effect diagrams or fishbone diagrams are used for identifying causes of risk. While drawing the Fishbone chart, care is taken to have the inner branches meet a horizontal straight line, called the "spine" of the chart. The statement of the problem - or the effect - is to the right of the spine inside a box, which makes it look like the head of a fish. When finished, the entire map resembles a fishbone.
2. System or process flow charts: A flowchart is a common type of chart, that represents an algorithm or process, showing the steps as boxes of various kinds, and their order by connecting these with arrows. Flowcharts are used in analyzing, designing, documenting or managing a process or program in various fields. Organization Assets
Project Planning
Auditing
Quality Control
Corrective Action
Verification
Figure 4: Flow chart diagram
3. Influence diagrams (ID): An ID is a directed acyclic graph with three types of nodes and one sub-type:
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Market Demand
Product Strategy
Customer Satisfactio
Product Verification
Figure 5: Influence diagram
•
•
Decision node (corresponding to each decision to be made) is drawn as a rectangle.
•
Uncertainty node (corresponding to each uncertainty to be modeled) is drawn as an oval.
•
Deterministic node (corresponding to special kind of uncertainty that its outcome is deterministically known whenever the outcome of some other uncertainties is also known) is drawn as a double oval.
•
Value node (corresponding to each component of additively separable) is drawn as an octagon (or diamond).
SWOT analysis SWOT Analysis is a strategic planning method used to evaluate the Strengths, Weaknesses, Opportunities, and Threats involved in a project. It involves specifying the objective of the project and identifying the internal and external factors that are favorable and unfavorable to achieving that objective. Strengths: attributes of the team or company those are helpful to achieving the objective. Weaknesses: attributes of the team or company those are harmful to achieving the objective. Opportunities: external conditions those are helpful to achieving the objective. Threats: external conditions which could do damage to the business's performance.
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PRO
CON
Internal
Strength
Weakness
External
Opportunity
Threat
Figure 6: SWOT analysis
Other identification techniques • hazard and operability studies - a HAZOP is a structured approach that systematically analyses every part of a process to identify how hazards, operability problems and deviations from design intent may arise; • quantitative analysis of safety risks and their impacts (QRA); • fault tree analyses - fault tree analysis is a systems engineering method for representing the logical combinations of the system states and possible causes that can contribute to a specified event (called the top event); • event tree analyses - an event tree describes the possible range and sequence of outcomes that may arise from the initiating event; • Other systems engineering techniques.
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Risk Register At this point the risk register would include: •
List of risks.
•
List of potential responses. Though risk response planning occurs later, one of the things experienced risk managers know is that it is not always logical to separate work on each part of risk management.
•
Root causes of risks previously explained, these are now documented.
•
Updated risk categories. You will notice lots of places where historical records and company records are updated throughout the project management process.
Table 7: Risk register at identification process Task Design Procurement
Handing out Executing
Verification
Cause
Risk
Effect
Conflict
Errors + Rework
Delay
Single supplier
Inappropriate delivery
Delay / cost increase
Permit not ready
No access
Delay
Technical problems
Rework
Delay / Cost increase
Nonconformance
Corrective action
Quality / Cost/ Time
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Risk Documentation Each element and each risk should be numbered, to facilitate storage and retrieval of information. Often the risk numbers are nested within the element number, and the nested numbering is extended as necessary as the analysis progresses. Each risk should be described. The risk description work sheet in Figure 5 provides one way of recording this. In practice, such sheets are used as summaries, supported by additional detailed or technical information. The description of the risk should include the main assumptions and mechanisms leading to the risk arising, the criteria likely to be affected, the phases of the project in which it is most likely to occur and notes on the consequences if it does arise. Sources of information should also be noted. Project: Element: Risk: Manager (risk owner): Description and mechanisms:
Reference:
Key assumptions:
Sources of information:
List of attachments:
Compiler:
Date:
Reviewer:
Figure 7: Risk reference sheet
29
Date:
Risk Responsibility Management responsibility for dealing with each specified risk and ensuring effective treatment plans are developed and implemented should be assigned and recorded. The responsible manager is sometimes called the risk owner. Information Source As a general rule, all available data sources should be used when assessing high-priority elements and risks, and evaluating ways of managing them. Information sources may include: • historical records, often for similar or related projects; • project experience, either specific to the kind of project being assessed or more general experience with large or complex activities or with similar kinds of contractors or suppliers; • industry best practice and user experience, including relevant benchmarks and standards; • relevant published literature and research reports, including appropriate theory, for example relating to failure modes or equipment reliability; • product brochures, technical manuals and audit reports; • test marketing and market research, where there is benefit in seeking or creating new information relating to specific aspects of the project, and particularly its acceptability to its intended end-users or customers; • experiments and prototypes, where there may be technical risks or areas in which more • empirical rather than theoretical information may be useful; • economic or other models, to provide the necessary theoretical foundations for specific and general risk assessments, including traditional cash-flow and sensitivity models where appropriate; • expert commercial and technical judgment, including that of the project team and • appropriate external advisers where necessary.
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Risk Allocation in Contracting In this session, the procurement cycle is examined to highlight the diversity of approaches to the allocation of risk in the supply. The appropriate procurement or contract strategy will only become apparent as the evaluation progresses from initial appraisal to full analysis, including consideration of potential areas for dispute because of known and unknown risks. Concept Risk acceptable Risk Assessment High - Low
Project Execution Plan
Contracting Strategy Design – Construction – Equipment – O&M
Novelty Complexity
Work - Motive – Risk transfer
Insurance Surety
Supply Chain Management
Validation of Contracting Strategy
Analysis of Incentives Analysis of Cost Liabilities Contract Language
Selection of Consultants, Contractors, Suppliers
Analysis of Cost Liabilities
Figure 8: Contracting process
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Objectives Partners
Known and Unknown Risks in Contracts The three main functions of contracts are: 1) work transfer: to define the work that one party will do for the other; 2) risk transfer: to define how the risks inherent in doing the work will be allocated between the parties; and 3) motive transfer: to implant motives in the contractor that match those of the client. During project appraisal, risks that may occur throughout the whole life of the project should be identified for the whole supply chain. These could then be considered based on (Smith–1999): •
which party can best control events;
•
which party can best manage risks;
•
which party should carry the risk if it cannot be controlled;
•
what is the cost of transferring the risk.
That is to say, some are pure risk, for example force majeure, while others' are created, for example, by the technology or by the form of contract or organizational structure. The client must ensure that, through the contract strategy chosen, his exposure to risk is optimized, considering both the up and the down side. Traditionally, risk in construction projects is allocated as follows (Figure 4): •
client to designer and contractor;
•
contractor to subcontractor;
•
client, designer, contractor, and subcontractor to insurer;
•
contractor and subcontractor to sureties or guarantors.
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Client
Contracto
Designer
Subcont. Insurer
Guarantor
Figure 9: Contractual risk transfer process
A number of clients list potential risks in the tender documents and request tenderers to price each of them as part of the tender; the evaluation of such risks and the price for their cover being part of the tender assessment criteria. The size of the contingencies employed by the contracting parties will be dependent upon a number of factors which may include the following: the riskiness of the project, the extent of the contractor's exposure to risks, the ability of the contractor to manage and bear the consequences of these risks occurring, the level of contractor competition, and the client's perceptions of the risk/return trade-offs for transferring the risks to other parties.
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Financial Risks Types of Financial Risks Financial risks are common to most projects. In some cases, the financial risks are dependent on the occurrence of other risks such as delay in construction or reduced revenue generation. Typical financial risks include (Mohamed and McCowan-2001, Smith–1999, Alexander-1998, Woodhouse-1993): •
Interest: type of rate, fixed, floating or capped, changes in interest rate, existing rates.
•
Payback: loan period, fixed payments, cash flow milestones, discount rates, rate of return, scheduling of payments.
•
Loan: type and source of loan, availability of loan, cost of servicing loan, default by lender, standby loan facility, debt/equity ratio, holding period, existing debt, covenants.
•
Equity: institutional support, take-up of shares, type of equity offered.
•
Dividends: time and amounts of dividend/coupon payments.
•
Currencies: currencies of loan, ratio of local/base currencies, depreciation and devaluation of currencies.
•
Market: changes in demand for facility or product, escalation of costs of raw materials and consumables, recession, economic downturn, quality of product, social acceptability of user pay policy, marketing of product and consumer resistance to tolls.
•
Reservoir: changes in input source.
•
Currency: convertibility of revenue currencies, fluctuation in exchange rates, devaluation.
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Both borrowers and lenders need to adopt a risk management program. Risk management should not be approached in an ad hoc manner but structured. The five major steps of such a process are: (1)
identify the financial objectives of the project;
(2)
identify the source of the risk exposure;
(3)
quantify the exposure;
(4)
assess the impact of the exposure on business and financial strategy
(5)
respond to the exposure.
The first stage is to develop a clear understanding of the project. Borrowers and lenders need to determine their objectives regarding the financing of a project. Many borrowers seek long-term loans with repayments made from revenues. The risk of not meeting repayments is often reduced when the borrower has sufficient earnings at the start of operation to service the debt. Many projects, however, suffer commissioning delays that increase the borrowers' loans and repayments. In many cases, borrowers will seek grace periods from lenders to cover such delays. Lenders seek positive cash flows and must ensure that their objectives are met by providing the best loan package. If a short-term loan is the lender's objective then the major risk will occur at the start of operation, and should the project not generate sufficient revenues the lender may need to consider debt for equity swaps. Once the project objectives are defined, the overall costs, including construction and operation costs, are determined and a cumulative cash flow model is prepared. The model can be used to quickly estimate the net present value (NPV), internal rate of return (IRR) and payback period of a project. It is essential that the estimates and programs prepared are reflective of cost and time over the project's life cycle. The risk of inaccurate estimates based on fixed budgets often leads to optimistic cash flows that do not truly illustrate the effects of risk occurring during a project.
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Financial Risk in Concession Contracts In the context of concession projects there are two types of risk, those being elemental risks and global risks and are defined as (Smith–1999, Alexander1998): (1)
elemental risks are those risks that may be controlled within the project elements of a concession project;
(2)
global risks are those risks outside the project elements that may not be controllable within the project elements of a concession project.
Risk management is not a discrete activity but a fundamental of project management techniques and the responsibility of the complete project team. In concession projects, the project team representing the promoter needs to determine the risks associated with each contract prior to appraisal (Woodhouse-1993). Financial risk, political risk, and technical risk must be considered as major elements of projects as are pre-completion and post-completion risks. Political risks may adversely affect the facility during either of these phases. Specific legal risks may be broken down into three broad categories: political risks, construction risks, and operational risks.
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Global and Elemental Risks In Concession Contracts In this section concession project risks are identified and classified into two categories (Griffis and Christodoulou-2000, Smith–1999): 1) global risks; 2) elemental risks. The four major global risks are: political, legal, commercial, and environmental risks. Political risks
Concession
Delay in granting concession, concession period, price setting by principal, public inquiries, enabling bill, commitment to concession contracts, exclusivity of concession, competition from existing facilities.
Legal risks
Host country
Existing legal framework; changes in laws during concession period; conflicting community, national or regional laws; changes in regulations regarding importation and exportation; changes in company law; changes in standards and specifications; commercial law, liabilities and ownership; royal decrees.
Agreement
Type of concession agreement, changes in obligations under legal framework, changes in provisions of agreement, statutory enactments, resolution of disputes.
Commercial risks
Market
Changes in demand for facility or product, escalation of costs of raw materials and consumables, recession, economic downturn, quality of product, social acceptability of user pay policy, marketing of product and consumer resistance to tolls.
Reservoir
Changes in input source.
Currency
Convertibility of revenue currencies, fluctuation in exchange rates, devaluation.
Environmental risks
Sensitivity
Location of project, existing environmental constraints. impending environmental changes.
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Impact
Effect of pressure groups, external factors affecting operation, effect of environmental impact, changes in environmental consent.
Ecological
Changes in ecology during concession period.
The four major packages associated with concession projects are: construction, finance, operation and maintenance, and revenue generation. Construction risks
Physical
Natural, pestilence and disease, ground conditions, adverse weather conditions, physical obstructions.
Construction
Availability of plant and resources, industrial relations. quality, workmanship, damage, construction period, delay, construction program, construction techniques, milestones, failure to complete, type of construction contracts, cost of construction, insurances, bonds, access, insolvency.
Design
Incomplete design, design life, availability of information, meeting specification and standards, changes in design during construction, design life, competition of design.
Technology
New technology, provision for change in existing technology. development costs.
Operational risks.
Operation
Operating conditions, raw materials supply. power, distribution of off take, plant performance, operating plant, interruption to operation due to damage or neglect, consumables, operating methods, resources to operate new and existing facilities, type of O&M contract, reduced output, guarantees, underestimation of operating Costs, licenses.
Maintenance
Availability of spares, resources, sufficient time for major maintenance, compatibility with associated facilities, warranties.
Training
Cost and levels of training, translations, manuals caliber and availability of personnel. training of principal's personnel after transfer.
Financial risks
Interest
Type of rate, fixed, floating or capped, changes in interest rate, 38
existing rates. Payback
Loan period, fixed payments, cash flow milestones, discount rates, rate of return, scheduling of payments, financial engineering.
Loan
Type and source of loan, availability of loan, cost of servicing loan, default by lender, standby loan facility, debt equity ratio, holding period, existing debt, covenants,, financial instruments.
Equity
Institutional support, take-up of shares, type of equity offered.
Dividends
Time and amounts of dividend payments.
Currencies
Currencies of loan, ratio of local/base currencies.
Revenue risks.
Demand
Accuracy of demand and growth data, ability to meet increase in demand, demand over concession period, demand associated with existing facilities.
Toll
Market-led or contract-led revenue, shadow tolls, toll level, currencies of revenue, tariff variation formula, regulated tolls, take and/or pay payments.
Developments Changes in revenue streams from developments during concession period.
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QUALITATIVE ANALYSIS This session illustrates the role of qualitative methods in risk management. Often the first stage in any analysis has to be a qualitative approach because there is insufficient information available to proceed with any quantitative methods. The value of a risk log is reviewed. Finally, the methodology is examined in detail. Qualitative Risk Assessment Qualitative risk assessment is the most useful part of the risk management process and it lays the foundation for all the subsequent stages in that process, including the quantitative analyses that are frequently required to define budgets and time-scales. Applying weighting factors to the qualitative assessment provides a quasiquantitative form of analysis. Review of Project Programs and Budgets It is important that a project's programs and budgets are realistic if it is to meet its objectives in terms of its quality and performance even as remaining within its predetermined time-scale and budget. Unless the budget and program are achievable, it is unlikely that risk analysis will predict the out-turn cost and duration. This depends upon several factors including: •
the experience of the project management organization;
•
the amount of relevant data from closely similar projects that can form the basis of performance specifications, estimates and programs;
•
the extent of innovation; and
•
the size and complexity of the project.
Budgets should be based on a realistic program for the work taking into account resource provision, productivity, time-related costs, and risks. Appropriate estimating techniques should be used for the type of project and the project stage at which the estimate is produced. The outline program should be checked to ensure that: •
all the key activities have been identified;
•
the durations are realistic; and
•
the logic links and any other constraints are correct. 40
Such constraints may include, for example, the links to, or dependencies on: •
other projects;
•
approvals for safety cases;
•
approvals by statutory authorities (planning permission, etc.);
•
approval of programs on method statements; and
•
approval of subcontracts and materials.
If the program is in network form, the critical path(s), free and total float must be identified. All assumptions underlying the budget and program must be identified and logged. Within each project the following interfaces must be identified to ensure that they are included in the program and managed effectively: •
between design groups;
•
between design groups and specialists;
•
between design and procurement;
•
between design and construction;
•
between procurement and construction; and
•
with other projects.
Management will be facilitated by ensuring that each such interface is logged as a risk so that the following data are recorded and the following actions are undertaken: •
define data each party requires from others;
•
define when they are required;
•
agree assumptions if data are not available on time;
•
log the assumptions;
•
revise assumptions until final data are available;
•
specify physical factors:
•
spatial positions;
•
loadings;
•
capacity, etc; 41
The Risk Log/Register The results of the interviews and reviews of the program and budget should form the basis for a risk log or risk register that will list all the identified risks. It will also contain assessments of their potential impact on the budget, program, and quality/performance aspects of the project. To aid manipulation, the risk log may include: •
project phase;
•
the owner of the risk;
•
location;
•
other use-defined categories, for example, cross-references to the project program and budget.
The risk log will also contain the information on actions to avoid, mitigate, or transfer risks, the secondary risks arising, and possible fallback plans.
Qualitative Methodologies Qualitative methodologies concern themselves with how management decisions are actually made, rather than the traditional operational research approach of obtaining the “right” answer. Methodologies that can screen out unfeasible alternatives, study the entire range of solutions, and explore the effect of likely constraints, will develop contrasting possibilities as to what is required. Placing decisions in the context of alternative future environments permits the opening up of discussions about threats and opportunities. Simplicity and clarity are sought, and uncertainty treated as a fact. Outside influences such as technical, commercial and political considerations are identified and considered in direct relation to internal issues.
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Risk probability & impact assessment This tool assesses the probability that the identified risk events will occur, and it determines the effect their impacts have on the project objectives, including time, scope, quality, and cost. Analyzing risks in this way allows you to determine which risks require the most aggressive management. Probability Probability is the likelihood that an event will occur. The classic example is flipping a coin. There is a 0.50 probability of getting heads and a 0.50 probability of getting tails on the flip. Note that the probability that an event will occur plus the probability that the event will not occur always equals 1.0. Determining risk probability can be difficult because it’s most commonly accomplished using expert judgment. This means you are guessing (or asking other experts to guess) at the probability a risk event will occur. Impact Impact is the amount of pain (or the amount of gain) the risk event poses to the project. The risk impact scale can be a relative scale that assigns values such as highmedium-low (or some combination of these) or a numeric scale known as a cardinal scale. Cardinal scale values are actual numeric values assigned to the risk impact. Cardinal scales are expressed as values from 0.0 to 1.0 and can be stated in equal (linear) or unequal (nonlinear) increments.
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Risk Probability and Impact The two dimensions of risk are applied to specific risk events, not to the overall project. Analysis of risks using probability and consequences helps identify those risks that should be managed aggressively. Table 8: Risk matrix Impact 0.9
0.7
0.5
0.3
0.1
0.9
0.81
0.63
0.45
0.27
0.09
0.7
0.63
0.49
0.35
0.21
0.07
0.5
0.45
0.35
0.25
0.15
0.05
0.3
0.27
0.21
0.15
0.09
0.03
0.1
0.09
0.07
0.05
0.03
0.01
Probability
Very low probability
Very high probability Very high impact
Very low impact
Figure 10: Determining priorities utilizing probability and impact of risk events
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A matrix may be constructed that assigns risk ratings (very low, low, moderate, high, and very high) to risks or conditions based on combining probability and impact scales. Risks with high probability and high impact are likely to require further analysis, including quantification, and aggressive risk management. A risk’s probability scale naturally falls between 0.0 (no probability) and 1.0 (certainty). Assessing risk probability may be difficult because expert judgment is used, often without benefit of historical data. An ordinal scale, representing relative probability values from very unlikely to almost certain, could be used. Alternatively, specific probabilities could be assigned by using a general scale (e.g., .1 / .3 / .5 / .7 / .9). Table 9: Detailed priority-setting matrix Consequences Likelihood
Insignificant
Minor
Moderate
Major
Catastrophic
Almost certain
Medium
Medium
High
High
High
Likely
Medium
Medium
Medium
High
High
Possible
Low
Medium
Medium
Medium
High
Unlikely
Low
Low
Medium
Medium
Medium
Rare
Low
Low
Low
Medium
Medium
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Table 14 shows an extended likelihood scale that was developed for a multipurpose set of assessments. Table 10: Likelihood scale Level
Descriptor
Description
Frequency
Probability
Very high, may occur at least once per year
1 per year
0.8 – 1
B
Almost certain Likely
Likely to arise at least once in a 1-5-year period
1 per 5 years
0.2 – 0.8
C
Possible
Possible, may arise at least once in a 1-10 years period
1 per 10 years
0.1 – 0.2
D
Unlikely
1 per 25 years
0.04 – 0.1
E
G
Very rare
1 per 100 years 1per 1,000 years 1 per 10,000 years
0.01 – 0.04
F
Very unlikely Rare
Not impossible, could occur at some time during the life of the facility May occur only in exceptional circumstances
A
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0.001-0.01 0.00010.001
Risk Evaluation Risk evaluation is about deciding whether risks are tolerable or not to the project, taking into account: • the controls already in place or included in project plans; • the likely effectiveness of those controls; • the cost impact of managing the risks or leaving them untreated; • benefits and opportunities presented by the risks; and • the risks borne by other stakeholders. The evaluation step compares risk priorities from the initial analysis against all the other risks and the organization's known priorities and requirements. Any risks that have been accorded too high or too low a rating are adjusted, with a record of the adjustment being retained for tracking purposes. The outcome is a list of risks with agreed priority ratings. Inherent risk As an extension of the evaluation process, the inherent risk level for each risk may be considered, using the four-point scale in Table 15. The inherent level of risk is the level that would exist if the controls did not work as intended, or if there were a credible failure of controls. Table 11: Inherent risk rating A
Extreme inherent risk
B
High inherent risk
C
Medium inherent risk
D
Low inherent risk
Risk data quality assessment The data quality assessment involves determining the usefulness of the data gathered to evaluate risk. Most important, the data must be unbiased and accurate. You will want to examine elements such as the following when performing this tool and technique: 47
• The quality of the data used • The availability of data regarding the risks • How well the risk is understood • The reliability and integrity of the data • The accuracy of the data Risk urgency assessment
Low severity
High severity
In addition to a list of risks, qualitative risk analysis includes noting risks that should move more quickly through the process. Reasons for this could include the fact that the risk may occur soon, or will require a long time to plan a response. Urgent risks may then move, independently, right into risk response planning, or they may be simply the first ones for which you plan a response.
Low urgency
High urgency
Figure 11: Urgency of risk events
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Table 12: Risk register Task
Cause
Risk
Effect
Probability
Impact
Conflict
Errors + Rework
Delay
High
High
Procurement
Single supplier
Inappropriate delivery
Delay / cost increase
Medium
Medium
Handing out
Permit not ready
No access
Delay
Medium
High
Technical problems
Rework
Delay / Cost increase
Low
Medium
Nonconformance
Corrective action
Quality / Cost/ Time
Low
Medium
Design
Executing
Verification
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RISK QUANTIFICATION The quantitative risk analysis process aims to analyze numerically the probability of each risk and its consequence on project objectives, as well as the extent of overall project risk. This process uses techniques such as Monte Carlo simulation and decision analysis to:
Determine the probability of achieving a specific project objective. Quantify the risk exposure for the project, and determine the size of cost and schedule contingency reserves that may be needed. Identify risks requiring the most attention by quantifying their relative contribution to project risk. Identify realistic and achievable cost, schedule, or scope targets.
Quantitative risk analysis generally follows qualitative risk analysis. It requires risk identification. The qualitative and quantitative risk analysis processes can be used separately or together. Considerations of time and budget availability and the need for qualitative or quantitative statements about risk and impacts will determine which method(s) to use. Trends in the results when quantitative analysis is repeated can indicate the need for more or less risk management action.
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Risk Quantitative Analysis The earlier chapters have set out a framework for managing risk. They describe risk management processes that are applicable to many forms of projects and different kinds of risk requirements. While the early chapters set out detailed processes for implementing risk management in a qualitative or semi-quantitative framework, they do not address quantification in any detail. The following chapters show how the aggregate uncertainty associated with a project can be evaluated using quantitative risk models in a variety of circumstances. Quantitative Modelling provides a means of: • describing the detailed mechanisms at work in a set of risks; • evaluating the overall uncertainty in the project to which they relate and the overall risk that this places on stakeholders; • establishing targets, commitments and contingency amounts consistent with the uncertainty the project faces and the risk the managers are willing to accept; and • exploring the relationship between detailed instances of uncertainty and an overall level of risk, to inform risk management resource allocation. The early chapters specify how to identify, evaluate and treat individual risks and groups of risks. However, an analysis of individual risks gives no indication of the combined effect of all the risks affecting a project. Quantitative Modelling provides a framework within which to integrate individual risks into an overall assessment to support decision-making and management control. In the case of large, complex or particularly sensitive projects, quantitative Modelling may also play a role in the evaluation of individual risks.
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General Approach Quantitative risk assessments extend the process described earlier to more detailed numerical analysis of uncertainty, usually in the context of a model of the project being examined. Often the model is implemented in a spreadsheet, incorporating the main cost or schedule aspects of the project and their interrelationships. Quantitative analyses come into their own when a view of the overall risk associated with a project is needed, such as when: • setting targets or accepting commitments; • evaluating the realism of estimates; • selling a project proposal on the basis of confidence in the forecast outcome; • assessing the return on major investments at pre-feasibility or feasibility stage; • choosing between alternative investments; and • choosing between alternative technologies with different risk profiles.
Risk tools
Deterministic model
Quantify risk
Risk responses
Probability calculation
Figure 12: Quantitative risk management model Risk Modelling may be viewed as an extension of conventional project and business forecasting and Modelling (Figure 19.1). Generally, a conventional spreadsheet is the starting point, such as a simple cost estimate or a cash flow model of the net present value (NPV) of a capital investment. The main elements of the model are examined to determine what might cause the elements to vary, and the likely management responses to variations are considered. The elements of a model, risks and responses are used to develop quantitative descriptions of the variability in the model expressed as distributions that replace simple fixed values in the spreadsheet. Of course, this requires special software, often in the form of a simple spreadsheet add-in, such as @Risk. The distributions are combined through the model structure to 52
generate distributions of the key variables need for decision making, such as the distribution of capital cost, NPV or rate of return (Figure 19.2).
Figure 13: Simulation Risk model parameters quantify uncertainty in the occurrence and the value of model components. Uncertainty in the occurrence of an event is described in terms of its probability of occurring. Uncertainty in the values of model components, such as their cost, duration, throughput or other characteristics, is described using probability density functions that are in turn defined by parameters such as minima, maxima, most likely or mean values. For example, Figure 19.3 shows an input distribution in density form, in this case estimated as a percentage variation around a base value. Such a distribution might be used to represent the uncertainty in an estimate of a cost at some time in the future, where the base cost is linked to a standard cost-estimating process and the risks are 'standard' estimating variations. Output distributions can be displayed in several forms. The one most people find immediately useful is the range of likely outcomes, and the risk of exceeding targets in that range. Figure 19.4 shows a typical example. If Figure 19.4 represented the capital estimate for a procurement, for instance, it would help in setting an overall budget target, generally towards the right-hand end, and establishing how much to release initially to the project budget, usually somewhere nearer the middle. It would also make it clear if earlier expectations had been realistic. Anything falling to the left of the range would be seen as very risky for all concerned.
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Risk models provide considerable information about the business or project being analyzed.
Figure 14: Accumulative probability after simulation They can show: • the realistically likely range of outcomes to expect; • the risk (or probability) of exceeding a target as a function of the value of the target; • the relative magnitude of various sources of uncertainty; and • the sensitivity of the uncertainty in the output to uncertainty in each input, highlighting the major risk drivers (which might not be those expected!). Application Applications of the quantitative risk analysis processes described in this book include, but are not confined, to the analysis of project-related aspects of: • project cost, schedule and cash flow; • enterprise or business cash flow (for example, where the project is a stand-alone entity, or the dominant commercial activity of a company or joint venture organization); • capital investment decisions; • processing system throughput; and • marketing and sales forecasts and project revenues. Such analyses can have a multitude of uses including: 54
• go/no-go investment decisions; • establishing or negotiating targets, commitments and contingency amounts; • evaluating the realism of established targets and commitments; • planning risk treatments that will reduce overall project uncertainty; and • prioritizing sources of uncertainty and establishing the extent to which various stake- holders can control the overall uncertainty in a project.
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Utility Theory Utility theory explains how rational people sometimes prefer outcomes, which do not have the highest monetary value (Raftery-1994, Thompson and Perry-
Utility
100
Risk averter Neutral
Risk seeker
50
0 Amount at Stake
Figure 15: Utility Curves 1992). Utility theory suggests that instead of maximizing expected monetary value, people may maximize their own utility. The equation that describes the utility curve is the utility function. Utility function varies from person to person. The utility function of an individual is unlikely to be identical to the utility function of that individual’s employing organization. It is also has been shown that people are not consistent and that an individual decision maker may demonstrate widely differing utility functions depending on the particular circumstances and on the size and the monetary amount under consideration (Figure 1).
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Risk attitude is concerned with the trade-off that people will make between uncertain payoffs of known probability and sure payoffs, again with known probability. The trade-offs are determined by asking decision-makers to specify how much sure money (the certainty equivalent) must be received to make them indifferent between the certainty equivalent and the expected value of a given amount that is not certain. For instance, if a person was given a choice between a 50% chance of winning £10,000 on a roulette wheel and a 50% chance of winning nothing or a 100% chance of winning £1,000 betting on a horse race and for a £500 stake winning, there would be some point where the decision-maker would be indifferent between the roulette wheel gamble and the horse race gamble. The decision is colored by how much the gambler can afford to lose and how much he needs to win. The relationship is between money and utility, where utility means the satisfaction the decision-maker receives from given quantities of money. Expected utility is a measure of the individual's implicit value, or preference, for each policy in the risk environment. This measure is represented by a numerical value associated with each monetary gain and loss in order to indicate the utility of these monetary values to the decision-maker. The utility measure can also be assigned to outcomes that have no monetary value. For the moment, let us restrict ourselves to monetary payoff situations which are more straightforward. The utility measures should be consistent, in order to reflect the preference of the decision-makers. The following rules must be obeyed: • the more desirable an outcome, the higher the utility measure will be. For example, winning £50 without any risk will have a higher utility measure than winning £5 without any risk; • if a decision-maker prefers outcome A to outcome B, and he prefers outcome B to outcome C, then A will be preferred to outcome C; • if a decision-maker is indifferent between two outcomes, they have equal utility; • in a situation involving risk, the expected utility of the decision equals the true utility of the decision. For example, assume that a particular strategy has an outcome 01 with a probability P1, and an outcome 02 with a probability P2 = 1- Pl. If we define the utility of 01 as U(01) and the utility of 02 as U(02), the expected utility of the strategy, which we define as the EU strategy is: EU(strategy) = P1*U(01) + (1 - P1) *U(02)
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Perform Quantitative Risk Management Data gathering & representation techniques This technique is like the interviewing technique discussed earlier. Project team members, stakeholders, and subject matter experts are prime candidates for risk interviews. They are asked about their experiences on past projects and about working with the types of technology or processes you’ll use during this project. When using this technique, it is required first to determine what methods of probability distribution. The chosen technique will dictate the type of information needed to gather. For example, the team may use the three-point scale that assesses the optimistic, pessimistic, and most likely risk scenarios or take it a step further and use standard deviations calculations.
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SENSITIVITY ANALYSIS Sensitivity analysis is discussed in detail in chapter 6; the purpose in this section is to give a brief overview. The discussion relates to the use of sensitivity analysis for life cycle costing but the approach is applicable to a wide range of activities. Sensitivity analysis is used to identify the impact on the total of a change in a single risky variable. The major advantage of sensitivity analysis is that it explicitly shows the robustness of the ranking of alternative projects. Sensitivity analysis identifies the point at which a given variation in the expected value of a cost parameter changes a decision. For example, when considering the life cycle costs, if the total costs of fuel exceed expectations by 10% does this change the preference between two alternative projects? Sensitivity analysis is an interactive process which tells you what effects changes in a cost will have; on the life cycle cost. By identifying the relative importance of risky cost variables, the decision-maker can adjust projects to reduce the risks and responses should the outcomes occur. A spider diagram is an effective way of using sensitivity analysis. The steps are: i) Calculate the expected total life cycle cost by using expected values. i i) Identify the variables subject to risk using a decision tree approach. iii) Select one risky variable, which we can call 'parameter 1', and re-calculate the total life cycle cost using different assumptions about the value of this parameter. The life cycle chosen is recalculated assuming that the cost parameter changes by 1%, 2%, and so on. iv) Plot the resulting life cycle costs on the spider diagram, interpolating between the values. This generates the line labeled 'parameter 1' as shown in Figure 2. v) Repeat stages iii) and iv) 'for the other risky variables. Each parameter line on the spider diagram indicates the impact on the life cycle costs of varying the value attributed to a particular parameter within the defined range. The flatter the line, the more sensitive will be the life cycle costs to changes in that parameter. In Figure 2, total life cycle is much more sensitive to variation in parameter 1 than it is to variation in parameter 2.
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Spider diagram The spider diagram tends to appear more difficult to read when more variables are plotted. The practical answer is to have several spider diagrams. We would recommend having a spider diagram for the financial and capital aspects of the project, and a separate spider diagram for running costs. The next question arises is whether there is likely to be a linear relationship between percentage changes in costs and changes in the expected value for total life cycle costs. In general, the spider diagram lines will not be linear, since if a running cost increases by x per cent it will be a relatively larger component of overall life cycle costs. Moreover, individual cost parameters may vary in many different ways.
Variation %
Sensitivity tests measure the effect on the model output of certain specified changes in the values of input variables and parameters. It is usual to begin with a deterministic output and to iterate through the model, examining the effect of changes in the input variables and assumptions. The resultant changes in model output may be presented as tables, graphs, or so-called spider diagrams. Sometimes an analyst will vary many of the input variables in sensible combinations. It would, of course, be unrealistic to decompose a model into a number of independent components and then examine what happens to the output if all the worst or best cases are added up (Figure 2). If the components of the model are independent, then the probability of all of the worst cases occurring simultaneously is a joint probability problem (Jovanović-1999, Thompson and Perry-1992).
Variable I
Variable II Variable III
(+)
0% Total cost of the project (-)
Variable IV
Figure 16: Spider diagram
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Sensitivity analysis is a technique used to determine how different values of an independent variable will impact a particular dependent variable under a given set of assumptions. This technique is used within specific boundaries that will depend on one or more input variables, such as the effect that changes in quality will have on a total cost of a project or an item. By creating a given set of scenarios, the management team can determine how changes in one variable(s) will impact the target requirements. The results of the analysis can be presented in the form of tornado diagram or spider diagram.
Inflation Currency Discount rate Market demand Conformance
-$2M -$1M $0M +$1M +$2M
Figure 17: Tornado diagram
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EXPECTED MONETARY VALUE The Expected Monetary Value (EMV) of each strategy is determined by multiplying the payoff of each outcome by its probability of occurrence and adding the products. For example, if an investor has two strategies either hold £150,000 in cash or invest the £150,000 in a project for which the options of return are £300,000 with a probability of 0.5 and £0 with a probability of 0.5, the EMV of the investment return is: EMV = 0.5 X 300,000 + 0.5 X 0 = £150,000 Under the probability choice criteria, the decision-maker's option is based on the rule: Strategy option = MAXi {EMV i} However, the two strategies have the same Expected Monetary Value (EMV) of £150,000, therefore, how the investor can make the decision of whether or not to invest. The following example shows another implementation of the EMV. A construction company is hiring equipment with a value of £50,000. It can buy insurance for £500 which will pay for replacing the equipment if it is damaged. The probability of the equipment being damaged is 0.05. There are two strategies: Sl: don't buy insurance S2: buy insurance and two events: El: equipment not damaged E2: equipment damaged Let us form the payoff table for this problem, taking losses as negative income. If the company buys the insurance, their cost will be £500, whether or not the equipment is damaged. The payoff matrix is shown along with the expected monetary value (EMV) computations. Using EMV criterion, the company would select S1 and not buy the insurance. Yet, in practice, many construction companies would, and actually do, purchase insurance. The prospect of a £50,000 loss somehow outweighs the £500 payment even with the low probability of risk. • each possible outcome is defined by a single number; • the outcomes are ranked in order of preference; • the objective is to maximize expected utility. The first step in deriving a utility function by the NM method is to determine two monetary outcome values as reference points. For convenience, we will look at the most favorable and least favorable monetary outcomes in a decision 62
situation. We then assign utility values to these two reference points. Since utility is an ordinal rather than a cardinal concept, these utility values are arbitrary. All that is necessary is that utility increases with the monetary gain. For convenience again, therefore, we might assign arbitrary utility values of 1 and zero, respectively, to these extreme monetary outcomes. Assume that the monetary return outcomes of a gamble range from £0 to £300. So we choose extreme monetary values of £0 and £300, assigning a zero utility to £0 and a utility of 1.0 to £300. That is, "' U(£0) = 0 and U(£300) = 1.0 The second step of the NM method is to assign the utility values for all the other monetary outcomes lying between these two extreme monetary outcomes. The utility values are determined in the NM method as the basis of the concept of certainty equivalent. Assume that the decision-maker has to choose between two strategies: Strategy A: a given amount of money with certainty (certain money) Strategy B: a risky environment with probability p of winning £300 and probability (1-p) of winning £0. To determine a certainty equivalent of strategies A and B, we can change the parameter values of either strategy A or B, or both, until a certainty equivalent is obtained. For convenience, assume p = 0.5 and (1-p) = 0.5 for strategy B and that the certain money of Strategy A increases from zero. When the certain money of strategy A reaches £100, it makes the decision-maker indifferent between strategies A and B. Therefore £100 is the certainty equivalent between strategies A and B. Its utility equates to the expected utility of strategy B: U(100) = pU(£300) + (1-p) U(£0) = 0.5*1 + 0.5*0 = 0.5 Probabilities P(El) = 0.95 P(E2) = 0.05 Table 13: Payoff matrix
S1 (Do not buy insurance) S2 (buy insurance)
E1: Not damaged
E2: Damaged
$0
-$50,000
EMV(S1)= -0*0.95 50,000*0.05 = -2,500
-$500
-$500
EMV(S2)=-500*0.95 500*0.05 = -500
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Expected Monetary value
Figure 18: Risk and the contractor
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Decision tree The concept of expected value can also be combined with "probability" or "decision" trees to identify and quantify the potential risks. Another common term is the impact analysis diagram. Decision trees are used when a decision cannot be viewed as a single, isolated occurrence, but rather as a sequence of several interrelated decisions. In this case, the decision maker snakes an entire series of decisions simultaneously. The process of constructing a decision tree can be complicated. Decision trees contain decision points, usually represented by a box or square, where the decision maker must select one of several available alternatives. Chance points, designated by a circle, indicate that a chance event is expected at this point. The following three steps are needed to construct a tree diagram:
Build a logic tree, usually from left to right, including all decision points and chance points. Put the probabilities of the states of nature on the branches, thus forming a probability tree. Finally, add the conditional payoffs, thus completing the decision trees.
The following illustration shows an example where a choice between good quality and poor quality product is required. The probability of using good quality product looks to be 60% while the probability of producing poor quality product is only 40%. Meanwhile, the probability of having a good market with respect to the specified product is 70% against only 30% probability for poor market. The expected income for each branch of the tree is shown as illustrated. The expected income for good quality product is L.E. 62,000 while that of poor quality product is only L.E. 29,000. On the other hand, the expected monetary value for the whole process is L.E. 48,800. N.B.: Expected monetary value for good market = 0.7 * 80,000 + 0.3 * 20,000 = L.E. 62,000 Expected monetary value for poor market = 0.7 * 50,000 - 0.3 * 20,000 = L.E. 29,000 Expected monetary value for the whole process = 0.6 * 62,000 + 0.4 * 29,000 = L.E. 48,800
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Good market P=0.7
L.E. 80,000
L.E. 62,000 Good quality P = 0.6
Poor market P=0.3
L.E. 20,000
L.E. 48,800 Good market P=0.7
Poor quality P = 0.4
L.E. 50,000
L.E. 29,000 Poor market P=0.3
L.E. -20,000
Figure 19: Decision tree example 1 The figure below shows a simple example for a decision tree. The general contractor has three options when tendering for three projects. He has the resources to undertake only one of the projects and must select the most profitable option.
Figure 20: Decision tree example 2
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The first option is to act as a general contractor submitting a lump sum bid for the re-building of a sea wall. The project has a likely profit of £400,000, but there is a chance that it could show a loss of £200,000. The second project is a design and build scheme for a new pumping station at a waterworks. The potential profit is £220,000, but again the project could show a loss, this time £100,000. The third project is a management contract for the refurbishment of an aircraft hangar with a potential profit of £160,000 but the possibility of a loss of £20,000. Reading the diagram from right to left, the contractor has put probabilities associated with the profit and loss for each project. The cost of bidding for the project is then deducted from the EMV to identify the project within the highest net EMV, which is the design and build scheme. Consider, for example, the sea wall. EMV = £400,000 X 0.6 - £200,000 X 0.4 = £160,000 less the bidding costs of £5,000 giving a net EMV of £155,000. Decision Definition
Decision Node
Chance Node
30%
Boom +900,000
Net Path value
900k -500k = 400k
Large Plant ($500,000) Large Plant or Small Plant
400*.3 -100*.7= 50k
70%
30%
Recess +400,000
400k -500k = -100k
Boom +300,000
300k -200k = 100k
Recess +160,000
160k -200k = -40k
Small Plant ($200,000) 100*.3 - 40*.7 = 2k
70%
Decision Node Chance Node End of Branch
Figure 21: Decision tree example 3 Decision trees are diagrams that show the sequence of interrelated decisions and the expected results of choosing one alternative over the other. Typically, more than one choice or option is available when you’re faced with a decision or, in this case, potential outcomes from a risk event. The available choices are depicted in tree form starting at the left with the risk decision branching out to the right with possible
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outcomes. Decision trees are usually used for risk events associated with time or cost.
SIMULATION Using this method the estimator need no longer be restricted to conventional estimates (Mulholland and Christian-1999, Vose-1996, Grey-1995, Raftery1994). If the estimator tends to choose “safe” figures then the result will be an over-conservative estimate. On the other hand, if the “most likely” figure is adopted then all the estimator's accumulated experience and judgment about other possibilities is lost when the results are added up to one single figure. By using computer simulation it is possible to carry through the estimate a complete judgment about the range of each variable and the relative likelihood of each value in that range. This judgment is made in the form of a probability distribution defined by the estimator, which reflects the sum of his or her knowledge about that variable. Using a simulation program, the project is “built” many times. Thus, we are able to observe the effect of the combined probabilities. On each “pass” through the project, the program selects for each item a cost that is chosen from the input distribution for that item. The simulation results in a statistical sample of projects with identical probabilistic characteristics, each of which has had a different outcome. Analysis of this sample enables us to attach some numeric evaluation to the degree of risk in the estimate. Choice of distribution The choice of input distribution is not based upon a search for the true distribution for the variable in question but on the objective of modeling the estimator's perception of the range and probability of the likely outcomes for it. The distributions chosen to work with in practical situations need to have certain desired characteristics. They should be relatively easy to understand and should have clear cut-off points. It is required to state reasonably clearly that the cost or time for a particular variable will never exceed X or be less than Y (Back et al.-2000, Fente et al.-2000, Maio et al.-2000, Guyonnet et al.-1999, Vose-1996, Grey-1995, Raftery-1994).
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Probabilit y
There is leeway to be somewhat flexible in the choice of input distribution, as errors in these distributions are improved by the effect of the Central Limit Theorem. The Central Limit Theorem implies that when a range of distribution shapes is entered and simulated many times, there will, as the number of simulations increases, be a tendency for the output distribution to tend to the normal shape. The precise choice of input distribution is not as important as the problem of correlation among the subsystems of the project model. It is important either to choose to analyze sources of risk that are reasonably independent or to expend a lot of time dealing with the connections between subsystems.
Minunum
Maximum
Figure 22: Uniform probability distribution
Figures (8), (9), and (10) show some types of probabilistic distributions. More details about possible distributions can be found in Appendix G. The distributions themselves are self-explanatory. In eliciting subjective probabilities and the parameters of the illustrated distributions, care should be taken to ensure that there are consistent rules for defining most likely, maxima and minima figures. Correlations and independence It is important to be aware of the trivia of the software being used to do the simulation. Most of the smaller programs and many of the more expensive ones do not deal with correlation. Some of the larger project management programs, which tend to simulate networks, claim to be able to deal with correlation but the detail of how strongly the links are defined is left to the user. Therefore, users need to be quite sophisticated in their understanding of probabilistic project models (Vose-1996). Correlation may be dealt with in this manner. Assume that activity P is dependent on the outcome of an earlier activity, say, activity K. The program 69
should allow for this to be flagged when entering the basic simulation model. For activity P a number of different distributions are entered, each one contingent upon a specific type of result from activity K. Now, in the simulation when it is time to draw a number for activity P, the program checks back to read the result drawn for activity K during the same pass. Reading this result, the program then decides which of the range of distributions for P is now appropriate, given the outcome of activity K. For example, the results of K could be banded into three different sections. A lower band producing a very optimistic result, a middle band and a higher band producing a pessimistic result. In this case, we could enter three distributions to activity P, one for each of the three cases. The correlation may be positive, where a good result in K implies a good result in P, or negative, where a good result in K implies a bad result in P.
Probability
However, it is also the case that the majority of all construction projects can be adequately simulated using very simple and inexpensive software. Detailed simulation of project activity networks is sometimes carried out for aerospace, defense and large undersea oil and gas exploration projects, but these are all much bigger, more heterogeneous, and more risky than most construction projects. Figure (14) shows sample output for simulated analysis for the duration of a sub-project. The upper figure shows the probability distribution based on 1,000 trials, while the lower figure shows the accumulative distribution of that outcome.
Minunum
Most likely
Maximum
Figure 23: Triangular probability distribution
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Probability
σ
σ (standard deviation)
µ (mean)
Figure 24: Normal probability distribution
Simulation is the art and science of designing a model which behaves in the same way as a real system. The model is used to determine how the system reacts to different inputs.
Figure 25: Probability density function
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Simulation is a further method of analyzing risk; it is basically a means of statistical experiment. Monte Carlo analysis is a form of stochastic simulation. It is called Monte Carlo because it makes use of random numbers to select outcomes, rather as a ball on a roulette wheel stops, theoretically at random, to select a winning number. The Monte Carlo simulation will require sets of random numbers to be generated for use in testing various options. Random numbers could be selected in a variety of ways such as picking a number out of a hat, or throwing a dice. In reality, using a computer program is the most effective method of generating sets of random numbers. Simulation makes the assumption that parameters subject to uncertainty can be described by probability distributions. In Monte Carlo simulation a large number of hypothetical projects are generated to reflect the characteristics of the actual project. Each simulation (or iteration, as it is known) is accomplished by replacing a risky variable with a random number drawn from the probability distribution used to describe that variable. Cumulative frequency curves are also usually presented as part of the results. From these it is a simple matter to read off the likelihood that a certain activity will not exceed a given time.
Figure 26: Probability distribution after Monte Carlo’s simulation
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Monte Carlo analysis is an example of a simulation technique. Monte Carlo analysis is replicated many times, typically using cost or schedule variables. Every time the analysis is performed, the values for the variable are changed using a probability distribution for each variable. Monte Carlo analysis can also be used during the Schedule Development process.
Figure 27: Accumulative probability distribution of budget after simulation
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Figure 28: Sample output of simulation process
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Many software packages are available for the probabilistic distribution analysis (Merna and Storch-2000). INFRISK is the package utilized by the Economic Development Institute of the World Bank. In INFRISK, the project data for the simulation is inputted both through an input sheet and the INFRISK dialog boxes. The input sheet contains fundamental project data for each year of the project. The data on this sheet is divided into two sections: one for the construction period and one for the operational period (Dailami et al.-1999). Once the main project data are entered in the input sheet, the user can specify the setting regulating functioning of the INFRISK simulation. This is done through the main dialog’s key function, which cover the following areas:
Macroeconomic Parameters Construction Cost Risk Variables Dept Capital Info Equity Capital Info Output Options
A generic form of probabilistic simulation is that utilized by the package called Crystal Ball. This package is compatible with the Microsoft package and can handle several types of distributions. Figure (14) shows sample output for the expected duration of partial project. Modeling and simulation techniques are often used for schedule risk analysis and cost analysis. For example, modeling allows translating the potential risks at specific points in the project into their impacts so it is possible to determine how the project objectives are affected. Simulation techniques compute the project model using various inputs, such as cost or schedule duration, to determine a probability distribution for the variable chosen. Cost risks typically use either a work breakdown structure or a cost breakdown structure as the input variable. Schedule risks always use the precedence diagramming method as the input variable. If a simulation technique is used to determine project cost and use the cost of the project elements as the input variable, a probability distribution for the total cost of the project would be produced after running the simulation numerous times. Modeling and simulation techniques examine the identified risks and their potential impacts to the project objectives from the perspective of the whole project.
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THE RISK PREMIUM • A discount rate reflects the investor's time value of money and the rate of return the property must earn to justify the investment. • The investor in land and property will balance the costs and the revenue of the investment over a period of time by using a discount rate. • Similarly the contractor and specialist contractor are looking at the investment of their resources and effort into a construction project: there is a risk of loss which is tempered by the possibility of gain. • They might use discounted cash flow techniques in order to evaluate the project. • The risk premium will be added to the risk free discount rate. • There are no formulae which derive an appropriate risk premium; each investor will have his or her own requirements as to the risk premium for each project. • Financial commitments always carry certain risks which can be neither eliminated nor transferred. • The term risk free is intended to imply not absolute absence of all risk, but virtual absence of default risk. • In financial terms, the risk free rate is taken as that which would apply if lenders viewed a borrower's credit and collateral so favorably that they were absolutely certain of repayment at the scheduled time. • Future risk is discounted more heavily than is near-term risk. • Arguably, the greatest uncertainty surrounds the initial construction period.
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RISK-ADJUSTED DISCOUNT RATE • It is tempting to consider the risk premium as the requirement for an additional rate of return. • A real discount rate used in say, life-cycle costing calculations, may be viewed as composed of three parts: a time value of money; an adjustment for expected inflation; and a risk premium. • The size of the premium depends upon the degree of risk associated with the project and the attitude to risk by the investor. • The greater the risk, the greater the premium. • In practice, a single risk-adjusted discount rate is added to the discount factor: RA = (RF + I + RP)t RA = Risk adjusted discount rate RF
= Risk free rate
I
= allowance for inflation
RP
= Risk premium which is the adjustment for extra risk above the normal risk
• A potential disadvantage of this approach has already been noted. Since the discount factor is part of a compounding function, the discount factor grows with increases in the value of (t). • This implies a special assumption that the risks associated with future costs and revenues increase geometrically with time. • A procedure for evaluating such projects is to separate timing and risk adjustments using the concept of certainty equivalent value (CEV). • The CEV of a cash flow in a given year is simply its risk adjusted value in that year. Hence, if all future cash flows were converted to CEVs, they could then be discounted to the present using a single risk free discount rate. • An alternative is to discount cost and benefit streams separately, each with a unique risk-adjusted (RA) discount rate.
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DECISION ANALYSIS Decision analysis deals with the process of making decisions. It is both an approach to decision-making and a set of techniques to guide decision taking under conditions of risk and uncertainty. They may be opportunities to exploit a chance to enter a new property market or plan a new development. Decision analysis follows a number of steps: • • • •
recognizing and structuring the problem; assessment of the values and uncertainties of the possible outcomes; determining the optimal choice; implementation of the decision.
The decision techniques considered in this section are fairly simple. They are: • • • • •
algorithms; means-end chain; decision matrix; decision trees; stochastic decision tree analysis.
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CERTAINTY, RISK, AND UNCERTAINTY Decision making falls into three categories: certainty, risk, and uncertainty. Decision making under certainty is the best and easiest case to work with. With certainty, we assume that all of the necessary information is available to assist us in making the right decision, and we can predict the outcome with perhaps 100 percent confidence. As we progress from certainty to risk to uncertainty, the potential damage to the project increases (Kerzner-1998, Raftery-1994, Chapman and Ward-1997). Decision Making Under Certainty Decision-making under certainty implies that we know with 100 percent accuracy what the states of nature will be and what the expected payoffs will be for each state of nature. Mathematically, this can be shown with payoff tables. To construct a payoff matrix, we must identify (or select) the states of nature over which we have no control. We then select our own action to be taken for each of the states of nature. Our actions are called strategies, which are actually the risks that we are willing to take. The elements in the payoff table are the consequences or outcomes for each risk. Table 14: Payoff matrix (profit in millions) State of nature
Strategy
N1
N2
N3
S 1 =A
$50
$40
-$50
S 2 =B
$50
$50
$60
S 3 =C
$100
$80
$90
A payoff matrix based on decision-making under certainty has two controlling features. Regardless of which state of nature exists, there will be one dominant strategy or risk that will produce larger gains or smaller losses than any other strategy or risk for all the states of nature. There are no probabilities assigned to each state of nature. (This could also be stated that each state of nature has an equal likelihood of occurring.) Decision Making Under Risk In practical situations, there usually does not exist one dominant strategy for all states of nature. In a realistic situation, higher profits are usually accompanied by higher risks and therefore higher probable losses. When there does not exist 79
a dominant strategy, a probability must be assigned to the occurrence of each state of nature. Risk is the totality effect of outcomes (i.e. states of nature) that can be described within established confidence limits (i.e., probability distributions). These probability distributions are obtained from well-defined experimental distributions. Consider Table (15), in which the payoffs for strategies 1 and 3 of Table (14) are interchanged for the state of nature N 3 . Table 15: Payoff matrix (profit in millions)
Strategy State of nature N 1 =0.25 N 2 =0.25 N 3 =0.5 S1
50
40
90
S2
50
50
60
S3
100
80
-50
From Table (15), it is obvious that there does not exist one dominant strategy. When this occurs, probabilities must be assigned to the possibility of each state of nature occurring. The best choice of strategy is therefore the strategy with the largest expected value, where the expected value is the summation of the payoff times and the probability of occurrence of the payoff for each state of nature. In mathematical formulation,
Ei =
n
∑ Pi, j p j j =1
where E i is the expected payoff for strategy i, P i,j is the payoff element, and p j is the probability of each state of nature occurring. The expected value for strategy S 1 is therefore = (50)(0.25) + (40)(0.25) + (90)(0.50) = 67.50
The expected value can be interpreted as the average value that the project manager can expect if he performs this effort 100 times. Repeating the procedure for strategy 2 and 3, we find that E 2 = 55, and E 3 = 20. Therefore, based on the expected value, the project manager should always select strategy S 1 . If two strategies of equal value occur, the decision can be made arbitrarily. The controlling factor in decision-making under risk is the assigning of the probabilities for each of the states of nature. If the probabilities are erroneously assigned, different expected values will result, thus giving us a different perception of the best risk to take. Suppose in Table (15) that the assigned 80
probabilities of the three states of nature are 0.6,0.2, and 0.2. The respective expected values are: E 1 = 56 E 2 =52 E 3 = 66 In this case, the project manager would always choose strategy S 3 . We can therefore see the importance of obtaining proper values for the probabilities of each state of nature occurring. Decision Making Under Uncertainty The difference between risk and uncertainty is that under risk there are assigned probabilities, and under uncertainty meaningful assignments of probabilities are nonexistent. As with decision making under risk, uncertainty also implies that there exists no single dominant strategy. The decision maker, however, does have at his disposal four basic criteria from which to make a management decision. Each criterion will depend on the type of project as well as the project manager’s tolerance to risk. The first criterion is the Hurwicz criterion, often referred to as the maximax criterion. Under the Hurwicz criterion, the decision maker is always optimistic and attempts to maximize profits by a “go-for-broke” strategy. This result can be seen from the example in Table (15). The maximax criterion says that the decision maker will always choose strategy S 3 because the maximum profit is 100. However; if the state of nature were N 3 , then strategy S 3 would result in a maximum loss instead of a maximum gain. The use of the maximax, or Hurwicz criterion, must then be bared on how big a risk can be undertaken and how much one can afford to lose. A large corporation with strong assets may use the Hurwicz Criterion, whereas the small private company might be snore interested in minimizing the possible losses. A small company would be more apt to use the Wald, or maximin criterion, where the decision maker is concerned with how much he can afford to lose. In this criterion, a pessimistic rather than optimistic position is taken with the viewpoint of minimizing the maximum loss. In determining the Hurwicz criterion, we looked at only the maximum payoffs for each strategy in Table (15). For the Wald criteria, we consider only the minimum payoffs. The minimum payoffs are 40, 50, and -50 for strategies S 1 , S 2 , and S 3 , respectively. Because the project manager wishes to minimize his maximum loss, he will always select strategy S 2 since it gives him the lowest risk. If all three minimum payoffs were negative, the project manager would select the smallest loss if these were the only options available. Depending on a
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company's financial position, there are situations where the project would not be undertaken if all three minimum payoffs were negative. Table 16: Regret Table
Strategy
States of Nature N1
N2
N3
Maximum regrets
S1
50
40
0
50
S2
50
30
30
50
S3
0
0
140
140
The third criterion is the Savage, or minimax criterion. Under this criterion, we assume that the project manager is a sore loser. To minimize the regrets of the sore loser, the project manager attempts to minimize the maximum regret; that is, the minimax criterion. The first step in the Savage criterion is to set up a regret table by subtracting all elements in each column from the largest element. Applying this approach to Table (15), we obtain Table (16). The regrets are obtained for each column by subtracting each element in a given column from the largest column element. The maximum regret is the largest regret for each strategy, that is, in each row. In other words, if the project manager selects strategy S 1 or S 2 , he will only be sorry for a loss of 50. However, depending on the state of nature, a selection of strategy S 3 may result in a regret of 140. The Savage criterion would select either strategy S 1 or S 2 . The fourth criterion is the Laplace criterion. The Laplace criterion is an attempt to transform decision making under uncertainty to decision making under risk. Recall that the difference between risk and uncertainty is a knowledge of the probability of occurrence of each state of nature. The Laplace criterion makes an a priori assumption based on Bayesian statistics, that if the probabilities of each state of nature are not known, then we can assume that each state of nature has an equal likelihood of occurrence. The procedure then follows decisionmaking value. Using the Laplace criterion, we obtain Table (16). Using the Laplace criterion, the project manager would therefore choose strategy S 1 .
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Table 17: Laplace criterion
Strategy
Expected value
S1
60
S2
160/3
S3
130/3
The important conclusion to be drawn from decision-making under uncertainty is the risk that the project manager wishes to incur. For the four criteria previously mentioned, we have shown that any strategy can be chosen depending on how much money we can afford to lose and what risks we are willing to take.
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BREAKEVEN ANALYSIS This technique is an application of sensitivity analysis. It can be used to measure the key variables which show a project to be either attractive or unattractive. A simple example for a project would be examining the critical rate of return with the cash inflow and initial cash outflow, the capital cost, the rate of inflation, the discount rate, and with a rent review every three years with the new rent being based upon the annual rate of inflation in the year preceding the review plus 2%. The rate of return is calculated by finding the appropriate rate which equates all future cash flows with the initial capital cost. The net present value criterion merely states that a project is worth undertaking if the present value of all future discounted cash flows is greater than, or equal to, the initial capital cost. The table below shows the data for a proposed investment with various assumptions. The results show a net present value of $2,555,848 which means that the project is not a good investment. The rental income would need to be $770,000 per annum in order for the project to be worthwhile if the other values remain constant. Capital cost (land, construction, fees, taxes)
$6 millions
Cash inflow (rental income)
$700,000
Cash outflow costs (running cost)
$200,000
Rent review period Rent review allowance above initiation in the final year preceding the review Discount rate
3 years
Time horizon
30 years
Net lettable floor area (rent $10/m2
70,000
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2% pa 12.5%
SCENARIO ANALYSIS This is a rather grand name for another derivative of the sensitivity analysis technique which tests alternative scenarios; the aim is to consider various scenarios as options. When undertaking a scenario analysis the key variables are identified together with their values. Option A Most likely Circulation space area 1,000 m2 required to meet the client’s requirements Net usable floor area of the 7,000 m2 building stipulated in the brief Gross superficial floor area of 5,000 m2 the building $1,000 Construction prices forecast for building cost per m2 at fourth quarter 1988 5% pa Inflation allowance for a 12 month design time and 12 month construction period Cost of providing car parking $500,000 and modifying the existing roads to meet state requirements
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Option B Optimistic 1,600 m2
Option C Pessimistic 2,300 m2
6,600 m2
7,300 m2
5,000 m2
5,000 m2
$950
$1,100
4% pa
8% pa
$400,000
$800,000
RISK RESPONSE Risk response and mitigation is the action that is required to reduce or eliminate the potential impact of risk. There are two types of response to risk - one is an immediate change or alteration to the project, which usually results in the elimination of the risk; second is a contingency plan that will only be implemented if an identified risk should materialize (Wideman-1992). In order to mitigate the potential impact of any risk the project manager or his designated risk manager must consider alternative courses of action and evaluate the consequences should that action be taken. As an integral part of the risk management process (RMP), the main aim of any response and mitigation strategy is to initiate and implement appropriate action to prevent risks from occurring or, at minimum, limit the potential damage they may cause (Tweed1996). Furthermore, through the use of adequate and appropriate contingency plans, if the occurrence of a risk is unavoidable, its impact should be limited to the contingency levels contained within the overall project allowances. This should ensure that the overall project objectives of time, cost, and quality are not jeopardized. The options for responding to risk are avoidance, reduction/mitigation, transfer/sharing, and retention/acceptance - each should be assessed as one or more will apply in every circumstance. In order to identify which route(s) should be adopted a number of questions must first be asked (Tweed-1996): •
is the risk controllable or uncontrollable
•
who is best placed to influence/deal with the source and outcome of the risk
•
what secondary or resultant risks arise as a result of the action taken
•
is the cost of mitigating the risk acceptable when compared to the potential impact of the risk itself?
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Strategies for Negative Risks or Threats Once risks have been identified and assessed, all techniques to manage the negative risk fall into one or more of these four major categories: •
Avoidance (eliminate)
•
Mitigation (reduce or control)
•
Transference (outsource or insure)
•
Acceptance (retain or assume)
Ideal use of these strategies may not be possible. Some of them may involve trade-offs that are not acceptable to the organization or person making the risk management decisions. Another source, from the US Department of Defense, calls these categories ACAT, for Avoid, Control, Accept, or Transfer. Avoidance This strategy includes not performing an activity that could carry risk. Avoidance may seem the answer to all risks, but avoiding risks also means losing out on the potential gain that accepting (retaining) the risk may have allowed. Not entering a business to avoid the risk of loss also avoids the possibility of earning profits. A simple example could like doing activities in parallel which usually being carries out in series to accelerate the performance of the project. This risk could be assumed if the project is behind schedule and the management team trying to catch up the due date of the project or phase. On the contrary, it is better to avoid this risk in the planning process. Risk avoidance may include a review of the overall project objectives leading to a reappraisal of the project as a whole. Risk avoidance is often perceived as the ultimate mitigation strategy in that it implies that the project may be aborted. In simple terms, this method of mitigation involves the removal of the cause of the risk and therefore the risk itself. Ideally any approach involving avoidance is best implemented by the consideration and adoption of an alternative course of action. Other examples of risk avoidance include the use of exemption clauses in contracts, either to avoid certain risks or to avoid certain consequences following from the risks. Risk avoidance is most likely to take place where the level of risk is at a level where the project is potentially unviable. Risk avoidance strategies are directed to eliminating sources of risk or reducing substantially the likelihood of their occurrence. Examples of risk avoidance include: • more detailed planning; • the selection of alternative approaches; 87
• improving designs and systems engineering, or adopting enhanced design standards; • procedural changes; • permits to work; • protection and safety systems; • preventive maintenance; • formal processes and quality assurance procedures; • operations reviews; • regular inspections and audits; and • training and skills enhancement.
Figure 29: Risk response
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Mitigation In this strategy it is targeted to reduce the severity of the loss or the likelihood of the loss from occurring. For example, sprinklers are designed to put out a fire to reduce the risk of loss by fire. This method may cause a greater loss by water damage and therefore may not be suitable. Halogen fire suppression systems may mitigate that risk, but the cost may be prohibitive as a strategy. Outsourcing could be an example of risk reduction if the outsourcer can demonstrate higher capability at managing or reducing risks. In this case companies outsource only some of their departmental needs. For example, a company may outsource only its software development, the manufacturing of hard goods, or customer support needs to another company, while handling the business management itself. This way, the company can concentrate more on business development without having to worry as much about the manufacturing process, managing the development team, or finding a physical location for a call center. Impact mitigation is directed to minimizing the consequences of risks. Some risks, such as those associated with economic variations or extreme weather conditions, cannot be avoided. The likelihoods of other risks arising may be reduced by risk prevention strategies, but the risks may still occur. In these cases, risk management must be directed to coping with their impacts, and ensuring that adverse consequences for the project and the project criteria are minimized. This method adopts an approach whereby potential exposure to risks and their impact is alleviated. Often this is achieved by the managing or designing out of potential risk. Methods of risks reduction may require some initial investment, which should then reduce the likelihood of the risk occurring. Risk reduction occurs where the level of risk is unacceptable and alternative action is available. Typical action to reduce risk could be: •
detailed site investigation where adverse ground conditions are known to exist but the full extent is not known;
•
alternative procurement route - by utilizing an alternative contract strategy risks will be allocated between project participants in a different way
•
changes in design to accommodate the findings of the risk identification process.
•
contingency planning;
•
engineering and structural barriers;
•
separation or relocation of an activity and resources;
•
quality assurance; 89
•
contract terms and conditions;
•
regular audits and checks to detect compliance or information security breaches; and
•
crisis management and disaster recovery plans.
Risk reduction exercises will always be worthwhile because they can lead to greater knowledge about the project and this reduces not only the potential impact of risks but also the level of uncertainty - itself a major source of risk. Risk reduction invariably leads to greater confidence regarding the project's outcome. However, risk reduction will result in an increase in the base cost but should offer a significantly greater reduction in the level of contingency required. It goes without saying that risk reduction should only be adopted where the resultant increase in costs is less than the potential loss that could be caused by the risk being mitigated.
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Transference In the terminology of practitioners and scholars alike, the purchase of an insurance contract is often described as a "transfer of risk." However, technically speaking, the buyer of the contract generally retains legal responsibility for the losses "transferred", meaning that insurance may be described more accurately as a post-event compensatory mechanism. For example, a personal injuries insurance policy does not transfer the risk of a car accident to the insurance company. The risk still lays with the policy holder namely the person who has been in the accident. The insurance policy simply provides that if an accident (the event) occurs involving the policy holder then some compensation may be payable to the policy holder that is commensurate to the suffering/damage. Transference of risk should comprise the passing of risks to those better placed or more capable to maintain control or influence the outcome of the risk. Transference should never be viewed as a negative risk response. Its intention is not to pass the buck by making someone else responsible. Further, it should not be used in a penal or disciplinary manner as a protective mechanism for other project participants. For risks to be managed properly an incentive may be required. When transferring risk it is important to differentiate between the transference of the risk itself and the allocation of risk responsibility. Where a risk is transferred the intention should be to transfer the whole of the risk including its potential impact. Where the responsibility for the risk is allocated to a project participant, time, cost, quality repercussions remain, and this may still adversely affect the project's outcome. Where a portion of the risk is transferred whilst some risk is retained this is known as risk sharing. This approach may be adopted where the risk exposure is beyond the control of one party. In such instances it is imperative that each party appreciates the value of the portion of risk for which it is responsible. Some ways of managing risk fall into multiple categories. Risk retention pools are technically retaining the risk for the group, but spreading it over the whole group involves transfer among individual members of the group. This is different from traditional insurance, in that no premium is exchanged between members of the group up front, but instead losses are assessed to all members of the group. Risk transferring occurs when contracts are negotiated between an organization and its suppliers or sub-contractors. Contracts are the primary means of allocating risk between the parties involved in most projects. However, transferring a risk with a contractor or supplier does not transfer it fully, and it may not really eliminate the risk - it just transforms it into a 91
'contractor failure' or 'contractor performance' risk. In these circumstances it is critical to ensure the contractor has a system in place for managing risk effectively, otherwise the project may end up with additional risks. In many projects, procurement contracts require sound risk management processes to be developed and implemented by the contractors, sub-contractors or suppliers of products or services, as part of prudential control and oversight procedures. Insurance is a well-known risk transferring strategy. It is normally used for physical assets and a limited range of commercial risks, particularly for the low probability but high impact residual risks that may remain after other risk treatment actions have been implemented. Transferring a risk with another party will usually incur a cost, for example an insurance premium, which provides a direct measure of the cost of transferring the risk. It should be noted that an insurance contract, like most contracts, is also a process that transforms the risk into something different: in this case, the insured party now has a credit risk that the insurer will not pay the full amount of a claim or will delay payment. Insurance is particularly relevant to the management of 'residual' risks, where active risk prevention and mitigation measures have been implemented. The remaining variability is a prime candidate for insurance.
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Acceptance Risk acceptance involves accepting the loss when it occurs. True self-insurance falls in this category. Risk retention is a viable strategy for small risks where the cost of insuring against the risk would be greater over time than the total losses sustained. All risks that are not avoided or transferred are retained by default. This includes risks that are so large or catastrophic that they either cannot be insured against or the premiums would be infeasible. War is an example since most property and risks are not insured against war, so the loss attributed by war is retained by the insured. Also any amount of potential loss (risk) over the amount insured is retained risk. This may also be acceptable if the chance of a very large loss is small or if the cost to insure for greater coverage amounts is so great it would hinder the goals of the organization too much. Sometimes risks cannot be avoided or transferred, or the costs of doing so would be high. In these circumstances, the organization must retain the risks. Nevertheless, risk prevention and impact mitigation measures and monitoring are usually recommended, at least in outline form. As most businesses in the private sector know, hedging or shedding all risks is rarely possible, and in any case it often costs so much that little or no profit can be made. In these circumstances, companies may become risk takers as an integral part of conducting their business, and reap the associated rewards. In some instances, organizations may wish to consciously retain significant risks, particularly where they have the appropriate expertise to manage them. Once all the avenues for response and mitigation have been explored a number of risks will remain. This does not imply that these risks can be ignored; indeed it is these risks, which will in most instances undergo detailed quantitative analysis in order to assess and calculate the overall contingency levels required. There are two types of acceptance strategy: 1- Active acceptance. The most common active acceptance strategy is to establish a contingency reserve, including amounts of time, money, or resources to handle the threat or opportunity. Some responses are designed for use only if certain events occur. In this case, a response plan, also known as “Contingency Plan”, is developed by the project team that will only be executed under certain predefined conditions commonly called “triggers.” 2- Passive acceptance. Requires no action leaving the project team to deal with the threats or opportunities as they occur. Workaround is distinguished from contingency plan in that a workaround is a recovery plan that is implemented if the event occurs, whereas a contingency plan 93
is to be implemented if a trigger event indicates that the risk is very likely to occur. The aim of the previous responses is to reduce project uncertainty and in so doing increase the base estimate to reflect the more certain nature of the project. However, it does not imply that these retained risks can simply be ignored. Indeed, they should be subject to effective monitoring, control, and management to ensure they are contained within the contingency allowances set. It should be noted that this contingency should be made up of residual risks, which are assessed, to be of a low likelihood and low potential impact. High probability and high impact risks should undergo further rigorous examination so that an alternative response can be found.
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Strategies for Positive Risks or Opportunities Risk is defined as exposure to the consequences of uncertainty. In a project context, it is the chance of something happening that will have an impact upon objectives. It includes the possibility of loss or gain, or variation from a desired or planned outcome, as a consequence of the uncertainty associated with adopting a particular course of action. The definition of risk is broader than ‘hazards’. The risk management process can embrace this broader definition, within the same basic approach as is used to manage the undesirable consequences of uncertainty.
Figure 30: Risk Analysis Matrix
Figure 31: Threats and Opportunities 95
Treatment options for risks having positive outcomes (opportunities) are similar in concept to those for treating risks with negative outcomes, although the interpretation and implications are clearly different. Options include: • actively seeking the opportunity by deciding to proceed with or continue the activity likely to create it (where this is practicable); • changing the likelihood of the opportunity, to increase the chance of beneficial outcomes; • changing the consequences, to increase the potential gains; • sharing the opportunity with others who can assist in any of the other strategies; and retaining the residual opportunity. After opportunities have been changed or shared, there may be residual opportunities that are retained with no further immediate action specified. This may be described as 'leaving it to chance'. The following table shows a selection of the Extreme and High opportunities for a business unit with responsibilities for conducting small and medium projects within its organization and for managing the provision by other companies of large projects. There are a number of points of interest in this example. • Consequence ratings were on the scale -A to -E for risks and A to E for opportunities. • The criterion that was most affected by each opportunity was noted. • The assessment of agreed priorities was extended to consider the inherent levels of opportunity. The inherent priority was interpreted as the potential opportunity that might be obtained if current plans and processes were implemented. • However, the members of the business unit preferred to think about it as an opportunity, in the sense that changing the pay and reward structure would generate far better business and project outcomes.
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Four strategies exist to deal with opportunities or positive risks that might present themselves on the project: exploit, share, enhance, and accept. Exploit When exploiting a risk event, the opportunities for positive impacts are aimed. This is the strategy of choice when identifying positive risks that you want to make certain will occur on the project. Examples of exploiting a risk include reducing the amount of time to complete the project by bringing on more qualified resources (as possible) or by providing even better quality than originally planned. Share The share strategy is similar to transferring because you’ll assign the risk to a third-party owner who is best able to bring about the opportunity the risk event presents. For example, perhaps what your organization does best is investing. However, it isn’t so good at marketing. Forming a joint venture with a marketing firm to capitalize on a positive risk will make the most of the opportunities. Enhance The enhance strategy closely watches the probability or impact of the risk event to assure that the organization realizes the benefits. This entails watching for and emphasizing risk triggers and identifying the root causes of the risk to help enhance impacts or probability. It is something like convincing the customer to enlarge the size of the project, adding more activities to the scope, or repeating the project again in terms to enhance the profit of my organization. Contingent response strategies The last tool and technique of the Risk Response Planning process is called the contingent response strategy, better known as contingency planning. It involves planning alternatives to deal with the risks should they occur. This is different from mitigation planning in that mitigation looks to reduce the probability of the risk and its impact, whereas contingency planning doesn’t necessarily attempt to reduce the probability of a risk event or its impacts. Contingency planning says the risk might very well occur, and you better have plans in place to deal with it when it does. Contingency comes into play when the risk event occurs. This implies you need to plan for your contingencies well in advance of the threat occurring. After the risks have been identified and quantified, contingency plans should be developed and kept at the ready. Contingency allowances or reserves are a common contingency response. Contingency reserves include project funds that are held in reserve to offset any unavoidable threats that might occur to project scope, schedule, cost, or quality. 98
It also includes reserving time and resources to account for risks. You should consider stakeholder risk tolerances when determining the amount of contingency reserves. Secondary Risk: A secondary risk can be defined as a risk created by the response to another risk. In other words, the secondary risk is a consequence of dealing with the original risk. A simple way to look at this is to think of project management as a chess game in which one has to think as many moves ahead as possible. One has to consider the reaction to the reaction, or in other words, the consequences that could arise from dealing with a problem or risk. Secondary risks are generally not as severe or significant as primary risks, but can become so if not anticipated and planned for appropriately. Residual Risk: It is these risks which remain after risk response planning, and those that have been accepted for which contingency plans and fallback plans can be created. Residual risks should be properly documented and reviewed throughout the project to see if their ranking has changed. Contingency Plans Contingency plans are plans describing the specific actions that will be taken if the opportunity or threat occurs. Workaround: Another type of corrective action is a workaround. Workarounds are unplanned responses to emerging risks that weren't accepted or identified. Workarounds give a way to "work around" the problem and as a result, reduce the effects that the risk has on the project. Workarounds should not be applied without documentation. Since using workarounds may have a positive or negative effect on the project, it is required to incorporate them into the project plan and risk response plan.
Risk register after planning risk responses Task
Cause Risk Effect Probability Impact Trigger Response Allocation Owner Residual risk Secondary risk
Design Procurement Handing out Executing Verification
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Contractual Risk Allocation Strategies Risk allocation strategies should be determined at the inception of the project by the client. Further risk management exercises may be undertaken during the course of a project but the reallocation of risk at this time is rare and will require negotiations with the contractor, which may or may not be successful. A contractor's exposure to risk must be related to the return that he can reasonably expect from a project. Thus if a contractor is making only a 5% return on a project, it is reasonable for a contractor's risk exposure to be restricted. Alternatively, tenders may be much higher than expected, reflecting the cost of transferring the risk to the contractor (Smith–1999).
Figure 32: Effectiveness vs. cost of change over time
The main characteristics of the available choices of risk allocation strategy can be grouped according to organizational structure or payment mechanism. Construction risks such as ground conditions, risk of non-completion, cost overruns and risk of delay are considered as major technical risks. Specification risk and errors in design that could have a detrimental effect on both construction and operation are also common. Physical hazards that may occur in the construction phase include force majeure, such as earthquake, flood, fire, landslip, pestilence, and diseases (Edawards-1995).
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Typical construction risks. Risk category Physical
Description Natural, ground conditions, adverse weather, physical obstructions
Construction
Availability of plant and resources, industrial relations, quality, workmanship, damage, construction period, delay, construction program, construction techniques, milestones, failure to complete, type of construction contracts, cost of construction, commissioning insurances, bonds, access and insolvency
Design
Incomplete design, availability of information, meeting specification and standards, changes in design during construction
Technology
New technology, provisions for change in existing technology, development costs and intellectual property rights and need for research and development
In the following subsections, a number of risk strategies are examined and their usefulness in a number of situations is discussed. Whatever approach is taken, the implications for the whole cycle of the project must be considered and the goals of all parties aligned. Conventional Approach This approach is commonly used in construction projects. The parties' roles and responsibilities are based on the separation of design from construction. The design is carried out by a consultant or in-house team, with limited contractor involvement, whereas the construction is the responsibility of the contractor with limited involvement of the client. The construction contract is usually supervised and administered by the design consultant working on behalf of the client. As the parties' responsibilities vary, their obligations, risk exposures and ability to carry risk also vary. This organizational structure usually allocates the risk of changes in the price of items to the contractor, while the risk of delay can be allocated to either the contractor or the client. The tendered prices used in this type of contract include a contingency for risk, which again means that the client is likely to pay more for the privilege of transferring the risks to the contractor than if he had accepted them himself. Cost-Based - Reimbursable Approach This form of contracting requires the client to take the majority of the risks as the contractor is paid on a cost plus fee basis but it also means that the client only has to pay for those risks that occur. The downside is that the client may pay for contractor's inefficiencies, which should be the contractor's risk. Cost101
reimbursable contracting can allow the contractor to have an input into the work at an early stage and this should help to reduce some of the project risks that may occur using a conventional approach.
Figure 33: Project risk exposure
Management Contracting Approach Management contracts are used by clients who want a third party to supervise and coordinate the design and construction of the project. These contracts require management contractors to place contracts for the packages of work and to oversee the project and ensure that the client receives what he initially specified. The client transfers all risks, except those associated with the operation of the project, to the management contractor. The management contractor can then transfer the risks that he holds through the contracts with the works contractors, as he wishes. The management contractor is usually reimbursed for all expenses he incurs, including those paid to subcontractors. A fee (either fixed or a percentage of the total) is usually paid to cover overheads and profit.
Fast-Track Approach The fast-track method of construction requires the compression of the design and construction stages by the overlapping of many activities and, although not a type of contract, fast track is a method of constructing the works that requires a much greater degree of control over the construction process. Fast-track projects are governed by contracts and it is necessary to choose a suitable type of contract to ensure that there is continuity in the work. This method of construction increases the risks in the project because the design of the work is not usually completed before the construction starts. If problems occur, they are less recoverable, from the program point of view, than if using conventional 102
methods of construction. This requires a large amount of coordination to ensure that construction is not halted because the necessary designs are not completed. The use of fast-tracking also means that the contractor must have a good relationship with his suppliers because he has very little advance warning of the exact quantities of goods that are required for a particular section of work. A management contract is often used for fast-track projects. Turnkey Approach For this approach, the client gives detailed specifications of what he requires and awards a single contract for the entire facility. It is then the responsibility of the contractor to design, construct, commission the facility, and ensures that it conforms to the client's specifications. The contractor can subcontract out the work, but it remains the contractor who deals with the client. The client's involvement in a project of this type is minimal. These contracts can be termed “turnkey”, “design-build”, or “package deal”. A BOOT (build, own, operate, transfer) approach can be similar to this organizationally but, in the case of BOOT projects, finance has to be raised by the promoter that is repaid (in the form of tolls or tariffs) over a concession period, and eventually the facility reverts to the ownership of the client organization. This type of project is very inflexible for the client, despite the reduction for risks that have to be accepted. If the client wishes to make any changes or alterations when the specifications have been given, it will result in increased premiums and increase the chance that the project will not meet its objectives. For the contractor, this type of project has increased the risks, but it does allow the contractor to use expertise and experience in planning and managing the work. Normally, the contractor is paid on a fixed price basis. There is no mechanism in this type of contract for price adjustments, so the price tendered by the contractor must include some allowance for changes in prices. The allowance included in the tendered price for price changes is the premium that the client pays for transferring the risk to the contractor.
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Firm Fixed Price (FFP)
Contractor incentive
Contractor risk
Fixed Price plus Incentive Fee (FPIF) Fixed Price with Economic Price Adjustments (FP-EPA)
Cost plus Fixed Fee (CPFF) Cost plus Incentive Fee (CPIF) Cost plus Award Fee (CPAF) Time & Materials Customer influence Customer risk
Figure 34: Factors influencing payment choice
This type of contract allocates the cost risk associated with the construction, and possibly the design work, to the contractor. There may be a clause in the contract that requires the contractor to pay the client in the event of a delay, but the inclusion of this clause is left to the discretion of the client. Otherwise, the risk of a delay in the project is retained by the client, along with all the other risks in the project. Risk Allocation According to Payment Mechanism According to this classification, there are two main categories: price-based and cost-based contracts. In the former the price and rates are submitted by the contractor in his tender. Lump sum (or fixed price) and admeasurement contracts lie under this category. The case is different for cost-based contracts where the contractor is reimbursed for the actual costs he incurs with a fee for overheads and profit. Cost-reimbursable and target-cost contracts are in this category. Lump Sum or Fixed Price Some clients wish to transfer all of the construction risks to the contractor and be certain of his commitment. Usually, the responsibility for the package is vested in a single contractor. The contractor agrees to carry out the work for money stated in the contract, regardless of its actual cost, as long as there is no change or breach of the contract from the client. This is quite common for 104
schools, warehouses, and similar works where the scope is relatively well defined and the work is straightforward. From the contractor's point of view, fixed price contracts are a good opportunity to maximize profits. As the client's involvement in the project is minimal, good planning, efficient use of resources and effective control can reduce costs and maximize profit. These contracts are normally let after competitive tender and so it is possible for the contractor to underestimate the costs involved. If this happens, he may not be able to cover the contract expense and, in extreme cases, he could become bankrupt. The quality of work and the program may also suffer. Admeasurement Admeasurement contracts require the use of a bill of quantities (BOQ) or schedule of rates. The work that the contractor is required to carry out is itemized, and it is necessary for the contractor to put a rate against each item of work. This method allows for the adjustment of price by the use of the itemized tendered rates. Uncertainty remains about the final price for the work because it does not necessarily follow that the lowest tender will be the one to give the lowest final price for the work. Admeasure contracts are commonly used in building and civil engineering projects, especially in the public sector. They are usually used when risks are relatively low and quantifiable, the program is almost fixed, and the design is almost complete and ready to be included in the tender. In cases where design and construction need to be overlapped, care should be exercised to ensure that there is sufficient information from which quantities can be obtained. Admeasurement contracts are more flexible than lump sum contracts because they allow additional work to be priced using the contractor's own pricing scheme. Under this type of payment mechanism, the client's main concern when entering into a construction contract will be the risk that the duration or cost of the project will exceed their estimates. The contractor's principal risk is that undertaken when he makes an offer based on his tender estimate. He accepts the possibility of incurring greater costs than the income provided by his prices. The contractor can include contingencies in his tender anywhere that he chooses, this being part of the skill of tendering. Cost Reimbursable and Target Cost The cost-based contract is one in which the contractor is reimbursed for the actual cost he incurred carrying out the contract works plus a specified fee for 105
overheads and profit. No total price is quoted at tender, competition is limited to the fee and technical capabilities and in most cases, and contracts are let after negotiation. Details of proposed management procedures and resources to be utilized must be given at tender. In the building industry, this tends to be known as “fee contracting”. Cost-based contracts have been used for process plant and some building and civil engineering contracts for several decades. The main use for costreimbursable contracts is for projects where there is a need for an early start while the scope is not well defined. They are also used for works where the quantity of work is not well defined, demolition, site clearing, repair works or incomplete contracts where work was interrupted, and for innovative works where research development or novel design is required. Cost-reimbursable contracts are appropriate in these cases because they are flexible and there is a high degree of client involvement through an active management role that gives the client confidence that the contract will be properly executed. In order to maximize benefits and to ensure that the work is carried out efficiently and economically, the client must maintain constant and detailed involvement in the project. The project team, in addition to technical and administrative supervision, must ensure that the contractor is utilizing resources efficiently. Outsourcing The outsourced provision of goods and service in an organizational framework can be considered in terms of three functions: • the internal or external customers who require goods or services; • the outsourced provider of the goods or services; and • a purchaser who must acquire those goods and services and ensure they continue to meet the customers' needs to an appropriate standard. To achieve organizational efficiencies many organizations have segregated and formalized these three functions. Many of the risks associated with outsourcing are associated with these three functions and their interrelationships. Adverse impacts of outsourcing may be associated with the purchaser, the provider or the customer or their interactions. • For the customer, outsourcing usually involves more formal and complex arrangements for the supply of goods and services and their payment. • For the purchasing function, this may require the organization to develop new skills and expertise for establishing, managing and monitoring the contractual relationship between the provider and the customer.
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• For management, outsourcing may mean a loss of technical expertise from the organization, with no guarantee it will be available if required in the medium to long term. Outsourcing may cause major changes to the nature and competence of organizations, particularly if the outsourced activity is a critical link in the organization's value chain. Once implemented, outsourcing may be difficult and expensive to reverse, due to the loss of in-house skills coupled with the difficulty in re-acquiring such skills. Outsourcing does not necessarily transfer the governance, accountability or risks associated with the outsourced function. The manager responsible for the outcomes of that function generally retains accountability for performance and the management of the risks associated with it. In addition, new risks emerge with outsourcing that in turn requires management attention.
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Contract Award The selection of external contractors is one of the crucial decisions made by the client if the project is to be a success. The criterion for selection may be price, time, or expertise. The price criterion is often the key objective issue as the client seeks the most economic price for the development, whereas time and expertise criteria are often seen as being less objective because of the need to expedite the construction program and the need for good quality workmanship (Alarcón and Mourgues-2002). The tender process may take a number of forms, the main distinguishing feature being the level of competition. Open tendering involves a high-risk element for the client, as many of the tendering organizations will be unknown. With selective tendering in either one or two stages, a limited number of organizations are invited to tender after some form of pre-selection or prequalification has taken place. In this case, award to the lowest conforming tender is not such a high-risk strategy. Negotiated tendering takes place when a client approaches a single organization, based on reputation, but this can also be time-consuming. The risk here is that at a later stage in the project the client may question whether value for money has been achieved in the absence of competition. The tendering process has three key stages: pre-qualification, tender documentation and bid evaluation. A number of factors will influence the pricing policy of the tendering organization, such as, competition, availability of resources and workload; however, these should not influence the criteria that the client uses for selection, but rather be taken into account as part of the client's evaluation. The contractual evaluation may be carried out as a separate assessment or as a part of the technical and financial evaluation. Compliance with the contract documents is considered paramount. Any qualifications included in the contractor's bid that had been accepted in the initial evaluation stage would be re-examined and clarified; if necessary, the bid may have to be rejected. The contractual evaluation is summarized in a report identifying those areas of risk and possible contractual problems associated with each of the bids. Contractual Sharing In Governmental Projects Charoenngam and Yeh (2001) presented a study on the contract sharing in governmental contracts. Most government-funded construction contracts are prepared by the government agencies or consulting engineers, and contractors are typically unable to influence the fairness of the contract conditions or clauses. Many of these government agencies have perceived that they can transfer risk and liability by placing major responsibilities upon contractors 108
through contract clauses. These clauses are intended to shift the preponderance of risk to contractors and associated insurers while minimizing the risk to themselves, the owners. This practice may result in high bid prices because contractors may add risk or uncertainty to the bid cost in the form of contingencies. Infrastructure construction projects are typically large, uncertain, and complex in many aspects. Therefore, they are subject to more risks related to economic, social, political, and environmental conditions than other types of construction projects. Should these risks materialize, they may have an impact on the cost, schedule, or quality of projects (or a combination of these). Construction risk can seldom, if ever, be eliminated. It can merely be transferred from one party to another. Grouping and prioritization of risks Rank 1 2 3 4 5 6 7 8 9 1 2 3 1 2 3 4 5 6 7 1 2 3 4 1 2
Description Score Construction Risk Factors Construction delay 191 Changes in work 185 Availability of resources 170 Delayed site access 158 Damage to persons or property 75 Late drawings & instructions 63 Defective design 63 Cost of tests and samples 48 Actual quantities 25 Physical Risk Factors Subsurface conditions – geology 196 Subsurface conditions – ground water 176 Acts of God 88 Performance Risk Factors Defective work 163 Productivity of equipment 145 Productivity of labor 89 Conduct hindering work performance 82 Suitability of material 80 Accidents 53 Labor disputes 39 Contractual & Legal Risk Factors Delayed dispute resolution 156 Change order negotiation 154 Delayed payment 86 Insolvency of contractor or owner 63 Financial & Economic Risk Factors Inflation 154 Funding 130
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Grouping and prioritization of risks Rank Description 3 National & international impacts Political & Social Risk Factors 1 Environmental issues 2 Regulations 3 Public disorder
Score 93 170 91 72
In large-scale infrastructure projects, risks and liabilities should be fairly shared among project participants through contractual arrangements. In order to prevent unexpected risks and thus disputes during construction, international contracts should pay close attention to local project characteristics and contract practices. Political reform and economic change in the last decades in the developing countries has led to dramatic changes for the society and the impact has been felt in the construction industry as well. Demand for efficiency of massive infrastructure development has forced developing countries to open their construction markets. Emerging large-scale international construction companies frequently challenge the fairness of government contracts for civil engineering projects. These, combined with the impact of the General Agreement on Trade in Services (GATS) on changing construction-related regulations, will cause changes in the environment of the construction industry in many countries as well as influence the contract strategies for future infrastructure projects. International competitive bidding procedures will be the standard practice; then, government agencies will be subject to much stronger pressure from the international construction industry to prepare fair construction contracts (Chapman et al.-2000).
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The Fundamental Risks-Liability and Responsibility The fundamental risks inherent in any construction project are apportioned between the client, the design team, the general contractor, the specialist contractors, and the material and component suppliers within the various contractual relationships. The risks are: • adequacy of design - which party bears the risk of liability for latent defects occurring as a result of errors in design? • cost of construction - which party assumes the risk of how much it will cost to build the project? • liability for latent defects arising as a result of bad workmanship, faulty materials, and poor specification- which party is responsible for the inadequacy, the professional team, the prime contractor, the specialist contractors, or the material suppliers? • safety and indemnification for all accidents - it is customary for one party to agree to indemnify the other for all damage and liability to third parties arising from the works; • completion deadlines - which party takes responsibility for completion to the agreed deadlines? • quality of workmanship and materials - which party takes responsibility for fitness for purpose and for ensuring the quality is acceptable? Risk Transfer by Surety Bonds In law a surety is a party that assumes liability for the debt, default, or failure in duty of another. A surety bond is not an insurance policy; it is the contract that describes the conditions and obligations of such an agreement. Insurance protects a party from risk of loss, while suretyship guarantees the performance of a defined contractual duty. The types of surety bond in use are: • bid bond ensures the contractor will stand by his tender bid; • performance bond ensures that if the contractor defaults, the project will be completed in accordance with the terms of the contract. All performance bonds have a face value which acts as an upper limit of expense the surety will incur;
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• labor and material payment bond protects the employer for labor and material used or supplied on the project. It protects against liens being filed on the project by unpaid parties to the work. Basic factors relating to risk in contracts: • what is the exposure inherent in the contract • who is most capable of handling that exposure • who has the responsibility for that exposure • who has the power to make sure that responsibility is carried out • what has been done to take account of the uncontrollable risks • to what extent have the risks been transferred
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Figure 35: Risk sources and corresponding offset
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Figure 36: Risk documenting
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Risk Action Plan The manager responsible for treating a risk may belong to the project team, the sponsoring business unit, or a functional area. Generally, responsibility should be allocated according to who is best able to deal with the matter. Responsible managers should complete Risk Action Plan summaries for each risk classified as extreme or high on the agreed risk priority scale. The structure of the summary is shown in Figure 6.8. • Extreme and High risks: All Extreme and High risks must be reduced. A detailed Risk Action Plan is required, with a one-page executive Risk Action Plan summary in the form shown in Figure 6.8. Similar risks, or risks for which a common treatment is indicated, can be grouped. All the boxes in the summary are required to be completed. The summary may be sufficient in many circumstances, but additional detail can be included if required, such as the benefit-cost analysis justifying the action. The summary can refer to existing work plans and processes. Managers should amend existing work plans appropriately. • Medium risks: All Medium risks should be reviewed and, where resources are available, suitable cost-effective reduction actions should be implemented and a Risk Action Plan summary completed (Figure 6.8). The aim should be to reduce all Medium risks unless it is decided, based on an assessment of costs versus benefits, to accept the risk. • Low risks: The managers responsible should take into account the identified risks, and ensure existing controls, plans and procedures are adequate to cover them. Where the risk is inherently Extreme or High, managers must also ensure that the control processes are being implemented correctly and effectively.
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Figure 37: Risk ranking
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Managing medium risks Although Extreme and High risks individually lead to the greatest potential problems, there are usually many more Medium risks than Extreme and High risks, and the effect of the Medium risks in aggregate may be significant. Accordingly, the Medium risks must be managed too. The assessment process for identifying and evaluating options for the management of Medium risks is similar to that described for Extreme and High risks. The level of detail required may be lower, but the same considerations apply. The management processes are often simple, depending on the complexity of the project organization: • designating the manager responsible for each risk area; • ensuring that each manager has plans developed to a level of detail appropriate to the requirement; and • ensuring the reporting and monitoring procedures are adequate for tracking the implementation of risk management activities.
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Determining Contingency The contingency sum, usually expressed as a percentage markup on the base estimate, is used in an attempt to allow for the unexpected. Construction and development is fraught with difficulty, and the basic notion of risk analysis is that it is useful to at least make an attempt to identify these risky items and attach some financial value to them. These amounts can then be added to a project budget as items of possible expenditure. The intention is that the project budget becomes a more realistic representation of the client's likely outlay (Smith and Bohn-1999). Thompson and Perry (1992) pointed out several weaknesses of using a contingency amount: • The percentage figure is, most likely, arbitrarily arrived at and not appropriate for the specific project. • There is a tendency to double count risk because some estimators are inclined to include contingencies in their best estimate. • A percentage addition still results in a single-figure prediction of estimated cost, implying a degree of certainty that is simply not justified. • The percentage added indicates the potential for detrimental or downside risk; it does not indicate any potential for cost reduction and may therefore hide poor management of the execution of the project. • Because the percentage allows for all risk in terms of a cost contingency, it tends to direct attention away from time, performance, and quality risks. • It does not encourage creativity in estimating practice, allowing it to become routine and mundane, which can propagate oversights. The use of risk premium money is regarded as standard practice in construction (Raftery 1994). The practice of presenting project cost estimates as a deterministic figure comprising a base estimate and the addition of a single contingency amount has been adopted in the construction industry for a long time for budgeting purposes. Usual practice is for this amount to be a single lump sum with no attempt made to identify, describe, and value various categories and possible areas of uncertainty and risk. In many cases it amounts to an educated guess at best. If there is some form of tender documentation provided to bidders, the contingency will usually be transferred to the provisional sums section in these documents.
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Mak and Picken Model In an attempt to deal with the determination of contingencies in a more analytical way, the Hong Kong Government implemented a technique called Estimating using Risk Analysis (ERA) in 1993. ERA produces similar base plus contingency cost estimates at pretender stage. For building projects that usually use the government's fixed quantities con-tract, the magnitude of the final account variations can be compared with the contingencies included in estimates (Mak and Picken-2000). In the ERA model, estimates are prepared at specific stages identified as Category C, Category B, and Category A. As the project becomes more definite, its category designation is changed – Category A being more certain than Category C. After identification the potential risks in the project, risks are categorized as either (1) fixed; or (2) variable. For each risk event, an average risk allowance and a maximum risk allowance are calculated. The relationship between risk category and risk allowance is shown Table. Relationship between risk allowance and risk category Type of risk
Average risk allowance
Maximum risk allowance
Fixed risk
Probability X maximum cost
Maximum cost
Variable risk
Estimated separately
Estimated separately
Assumption
50% chance of being exceeded
10% chance of being exceeded
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Figure 38: ERA calculation
The ERA process is usually carried out several times during the pretender period for any one project. Figure (22) shows the ERA calculations for one of these stages. As the project develops, some events that were originally identified as uncertain will be clarified and will be either deleted or included in the base estimate as a certainty. The following table presents a summary of completed projects that detailed the contract sum, original contingency, amount of additions, amount of omissions, final account amount, and start date of 322 building projects.
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Summary of raw data Statistics
Non-ERA projects ERA projects 287
45
Contract sum (minimum)
0.31 M
0.99M
Contract sum (maximum)
1331.01 M
208.48 M
Contingency (minimum)
0.15 M
0.08 M
Contingency (maximum)
110.00 M
38.00 M
Contingency/contract sum (minimum)
0.67%
4.02%
Contingency/contract sum (maximum)
137.40%
18.23%
Final account variation (minimum)
6.00 K
41K
Final account variation (maximum)
85.98 M
27.39 M
DEVI (minimum)
0.10
0.30
DEVI (maximum)
45.00
6.64
Number of projects
Contingency Management Model by Ford Ford (2002) proposed a model to test hypotheses of the effectiveness of aggressive and passive management strategies on cost, timeliness, and facility value. Managers were found to pursue general project objectives in their management of contingency. Hypotheses Hypotheses were developed concerning how contingency management strategies impact the performance of different types of projects. Better performance is measured by more emergencies resolved, reduced delays, and facility improvement. Projects are described with their management difficulty, as described by the amount and nature of their uncertainty, and the project cost structure. Contingency management strategies are aggressive or passive. An aggressive strategy reallocates funds quickly, uses contingency to correct schedules before many emergencies have been discovered and resolved, and applies funds early to improve the facility. In contrast, a passive strategy reallocates slower, postpones using contingency until it must be used to meet critical objectives, and uses little funds for improvement until emergency and schedule objectives are met.
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If sufficient contingency funds are available, all emergencies are resolved, deadlines are met, and facilities are improved. Under these conditions, many contingency management strategies are effective. But when resources constrain performance projects that are more difficult to manage (are uncertain and have higher costs), are expected to cost more, take longer, and improve facilities less. Four hypotheses were utilized in the model as: Hypotheses 1 (H 1)-performance decreases with increasing management difficulty. Hypotheses 2 (H2)-the percent of emergencies resolved are less and delays are larger using an aggressive strategy than when using a passive strategy for a fixed level of management difficulty. Hypotheses 3 (H3)-the value added using an aggressive strategy is larger than the value added using a passive strategy for a fixed level of management difficulty. Hypotheses 4 (H4)-performance decreases less as management difficulty increases using an aggressive strategy than a passive strategy. Contingency Management Model Modeling describes the observed contingency management mental models. In this way, the interactions and potential flaws of contingency managers are captured better than in more complete and detailed models. The model has four subsystems: (1) escrow accounts; (2) emergencies; (3) schedule control; and (4) facility improvement. The escrow accounts subsystem simulates the monetary requirements, accumulations, and dynamic allocations of money among the four accounts and the use of contingency. The emergencies subsystem models the discovery and resolution of emergencies. The schedule control subsystem models the effects of emergencies on schedule performance and the perception and management of delays. The improvements subsystem simulates the addition of value to the facility by spending contingency funds. Each subsystem also models one form of contingency management performance. The simulation model is a set of nonlinear difference equations that describe the information structures and decision-making processes used to manage contingency. Because no closed form solutions are known, the behavior of the system was simulated over time.
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Contingency management performance Performance Project Management Conditions Measures Easiest Easy Difficult Most difficult
Total change
Emergency resolution (percent of total emergencies resolved) Aggressive strategy
91.0
70.7
61.0
47.5
-43.5%
Passive strategy
100.0
76.7
68.0
51.2
-48.8%
Schedule control (actual duration as percent of planned duration) Aggressive strategy
106.1
116.5
153.2
156.6
+50.5%
Passive strategy
100.0
114.2
152.5
157.7
+57.7%
Facility improvement (thousands of dollars of value) Aggressive strategy
53.5
24.3
27.8
20.6
-61.5%
Passive strategy
37.1
4.3
4.6
3.6
-90.2%
The table above shows the performance of the aggressive and passive strategies in resolving emergencies, controlling the project schedule, and facility improvement for each of the four project management conditions, as well as, the total change in performance across project management conditions.
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BOT Projects Risk Assessment Zayed and Chang Model Zayed and Chang (2002) presented a model to anticipate the risk index (F), which is a prototype-developed evaluation tool, composed of one-level hierarchical structure that consists of the main eight BOT risk areas. Figure (26) shows the eight risk areas that the study focused on: political, financial, revenue, promoting, procurement, development, construction, and operating.
Figure 39: BOT projects main risk areas
The objective of the risk factor (F) is to evaluate whether a particular project should be privately promoted based on BOT risk. It assesses the degree of BOT project exposure to risk areas. The risk index (F) can be presented by adding the risk areas’ value function as follows: where; F = risk index for BOT project (probability of failure); W i = weight for each risk area I using Eigen value method; F =δ
n
∑
i =1
V i (x i ) = worth score for each risk area (x i ); X i = different risk areas i; i =1,2,3,….,n; 124
Wi * Vi ( xi )
n=number of risk areas (8); δ=constant The term (δ) was introduced to account for situations where a single dominant attribute’s performance level is so low that it is sufficient to render a company incapable of promoting the project. The (δ) factor is calculated by multiplying the delta of each of n dominant risk area falls below a certain threshold, P1, set by the decision maker (cutoff point), then its δ i =0 whenever a dominant risk area I has a performance level x i ≤P1 [ that is, whenever V i (x i ) = 0]. The qualitative risk area measurement scale used to quantify the qualitative assessment of any risk area i is shown in Figure (28).
Figure 40: Qualitative risk area measurement
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Risk in BOT Projects Askar and Gab-Allah (2002) presented this study aiming to investigate the potential for implementing the BOT system in the Egyptian environment. This could be achieved by giving a clear view of BOT and of its problems, risk areas, and features, pertaining to the Egyptian environment, in order to maximize the benefits and minimize the risks as much as possible.
Figure 41: Comparison between expected and actual risk factors in project
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The collected data was analyzed based on actual implementation in Egypt. This involved the following: (1) An overview of the critical success factors in order to achieve a BOT project; (2) an analysis of results obtained from questionnaires seeking to determine the possibility of occurrence of the different risk factors in the Egyptian environment, and their ranking; (3) a comparison between the questionnaire results and the actual risks from requests for the proposal of locally advertised projects; and (4) a determination of the missed critical success factors in the Egyptian environment. The main conclusion of this study is that three critical success factors are essential for the success of BOT projects in Egypt: (1) Picking the right project; (2) competitive financial proposal; and (3) special features of bid. The analysis of seven RFPs of locally advertises BOT projects revealed the common risk factors that are shared in these projects. Figure (29) presents a comparison between the results obtained by questionnaire and those obtained by analysis of locally advertised BOT projects. Political Risks in BOT Projects Wang et al. (1999 and 2000) presented the result of their investigation about the risk management of BOT projects in developing countries. The objectives of the study were to (1) identify the unique or critical political and force majeure risks associated with China’s BOT projects, and (2) evaluate the effectiveness of mitigation measures that are available to manage these risks. The categories targeted in the study were; Chinese parties’ reliability and creditworthiness, change in law, force majeure, delay in approval, expropriation, and corruption, as shown in the following table.
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Unique/Critical Political and Force Majeure Risks and Mitigating Measures Risk (1)
Measure 1 (2)
Measure 2 (3)
Change in law
Obtain government's guarantees (e.g., adjust tariff or extend concession period)
Insurance political risk
Corruption
Maintain good relationship with government authorities, especially officers at state or provincial level Establish JV with local partners, especially central government agencies or state-owned enterprises Establish JV with local partners, especially central government agency or state-owned enterprise Gain accurate information (e.g., financial, etc.) about Chinese entities and choose most capable ones Obtain government's guarantees to adjust tariff or extend concession period
Establish JV with local partners, especially central government agency or state owned enterprise Obtain government's guarantees to adjust tariff or extend concession
Delay in approval
Expropriation
Reliability and creditworthiness of Chinese entities
Force majeure
for
Measure 3 (4)
Measure 4 (5)
Maintain good relationship with government authorities, especially officers at state or provincial level Enter into contract to prevent corruption
-
Maintain relationship governments approvals
good with
-
Ask government to establish one-stop agency for all
Relay on a combination of international consortium and insurance policies (political insurance) Maintain good relationship with government officers at state or provincial level
Obtain support of sponsor's government (e.g., export credit)
-
Appoint independent accountant to audit the Chinese entities
-
Insure all insurable force majeure risks
Obtain government's guarantee to provide financial help if needed
-
Based on the previous table, a questionnaire for international survey was designed. There were three parts: (1) criticality of risk, (2) effectiveness of the proposed mitigating measures, and (3) adequacy of related in contracts. The following table presents the findings of the criticality of political and force majeure risks. The “criticality index” was calculated for each risk using the following formula: Critical index = (5n 1 + 4 n 2 + 3 n 3 + 2 n 4 + n 5 ) / 5 (n 1 + n 2 + n 3 + n 4 + n 5 ) where n 1 = number of respondents who answered “extremely critical”, n 2 = number of respondents who answered “very critical”, n 3 = number of respondents who answered “critical”, n 4 = number of respondents who answered “fairly critical”, and n 5 = number of respondents who answered “not critical”. R
R
R
R
R
R
R
R
R
R
R
R
R
R
R
R
R
RR
R
128
R
R
R
R
R
R
R
R
R
R
R
R
Criticality of Political and Force Majeure Risks Survey respondents (%) Very Critical Fairly Not critical critical critical (3) (4) (5) (6)
Risks of BOT projects in China (1)
Extremely critical (2)
Criticalit Not applicable y index (8) (7)
Mean score (9)
Ranking
Chinese entities reliability
52
33
15
0
0
0
0.87
4.36
1
Change in law
52
36
6
6
0
0
0.87
4.33
2
Force majeure
34
34
22
9
0
0
0.79
3.94
3
Delay in approval
24
30
36
9
0
0
0.74
3.70
4
Expropriation
44
13
19
13
13
0
0.73
3.62
5
Corruption
9
18
38
18
9
9
0.55
2.74
6
(10)
Risk Reduction in BOT Projects Yeo and Tiong (2000) proposed a risk reduction framework based on relevancy ideas of systematic thinking, especially the soft systems methodology (SSM) (Figure 30). Case examples of successful and non-successful BOT projects are selectively used to illustrate elements of framework. The proposed risk reduction framework was addressed under the following three aspects: 1. Positive management of differences to achieve convergence for results. 2. proactive control of variation in critical variables. 3. strong entrepreneurial leadership and consortium. The first is the dominant theme and the second on control of variation is a subset of the first. Though the former is more qualitative in nature while the latter quantitative. The ideas are systemic because they are built on the concepts of both soft systematic thinking and the ‘harder’ systems analysis and systems engineering. The third idea of a strong entrepreneurship and consortium as ‘human actors’ could be a decisive factor in overall risk management and reduction. The perception and resolution of risk are relative to the problem solving capability of the human actors. To provide a useful basis for taking a rounded view of the business process and effective stakeholder management, the systemic approach suggests a set of six elements (CATWOE) represented by customer (C), actor (A), transformation (T) process, worldviews (W), owner (O), and environment (E), respectively. The intention is to find a way to minimize the danger of irreconcilable differences I perception among the stakeholders, and to enhance chances for success.
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Figure 42: Soft systematic negotiation model for BOT concession projects
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Exchange Rate Risk Management Foreign exchange exposure refers to the risk that future changes in a country's exchange rate will hurt a firm. Foreign exchange exposure can be divided into three categories: transaction exposure, translation exposure, and economic exposure. Kapila & Henderichson (2001) categorized the types of forex risk exposure as follows: Transaction exposure is typically defined as the extent to which the income from individual transactions is affected by fluctuations in foreign exchange values. Such exposure includes obligations for the purchase or sale of goods and services at previously agreed prices and the borrowing or lending of funds in foreign currencies. Translation exposure is the impact of currency exchange rate changes on the reported consolidated results and balance sheet of a company. Translation exposure is basically concerned with the present measurement of past events. The resulting accounting gains or losses are said to be unrealized. They are "paper" gains and losses, but they are still important. Translation exposure can have a very negative impact on a firm. Economic exposure is the extent to which a firm's future international earning power is affected by changes in exchange rates. Economic exposure is concerned with the long-run effect of changes in exchange rates on future prices, contracts, and costs. This is distinct from transaction exposure, which is concerned with the effect of exchange rate changes on individual transactions, most of which are short-term affairs. Tactics and Strategies for Reducing Foreign Exchange Risk A number of strategies and tactics can help international contractors reduce their foreign exchange exposure. The tactics are best suited to alleviating transaction exposure and translation exposure. Reducing Transaction and Translation Exposure Future currency exchange contracts (called "buying forward") and netting currency transactions (aggregation of costs and incomes for the same currency) are important sources of insurance against the short-term effects of foreign exchange exposure. Buying forward involves a currency contract for future sale or purchase of a foreign currency at a predefined exchange rate rather than the market rate at the time of the transaction. Terms of these forward contracts are set by the forward market itself and will vary with expectations of currency movements and the 131
demand and supply of the currency transaction requests. The forward contracts may be firm commitments for transactions or may be options in which the purchaser can decide at the time of maturation whether or not to exercise the future contract. Future options have the advantage that favorable foreign exchange movements might result in extra profits, but the options will normally have a corresponding charge. Firms can also reduce their foreign exchange exposure through managing the timing of payables and receivables. A firm might collect and pay early or late depending on expected exchange rate movements. This timing involves accelerating payments from weak-currency to strong-currency countries and delaying inflows from strong-currency to weak-currency countries. Reducing Economic Exposure Reducing economic exposure requires strategic choice that goes beyond the realm of financial management. The key to reducing economic exposure is to distribute the firm's productive assets to various locations so the firm's longterm financial well-being is not severely affected by adverse changes in exchange rates. Developing Policies for Managing Foreign Exchange Exposure The international contractor needs to develop a mechanism for ensuring it maintains an appropriate mix of tactics and strategies for minimizing its foreign exchange exposure. Although there is no universal agreement as to the components of this mechanism, a number of common themes stand out. First, central control of exposure can help protect resources and ensure that each subunit adopts the correct mix of tactics and strategies. Central depositary allows having larger amounts in liquid accounts, have access to information about good short-term investment opportunities, and reduce the total size of the cash pool it must hold in highly liquid accounts (Hillson-2002). Second, firms should distinguish between, on one hand, transaction and translation exposure and, on the other, economic exposure. Many companies seem to focus on reducing their transaction and translation exposures and pay scant attention to economic exposure, which may have more profound longterm implications. Third, the difficulty to forecast future exchange rate movements cannot be overstated. The best that can be said is that in the short run, forward exchange rates provide reasonable predictions of exchange rate movements, and in the long run, fundamental economic factors-particularly relative inflation ratesshould be watched, because they influence exchange rate movements. 132
Fourth, construction firms need to establish good reporting systems so that the central finance management can regularly monitor the firm's exposure positions. Finally, on the basis of the information it receives from exchange rate forecasts and its own regular reporting systems, the firm should produce regular foreign exchange exposure reports. The reports can then be used by management as a basic for adopting tactics and strategies to hedge against undue foreign exchange risks.
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RISK MONITORING Under the heading 'risk management' in the meeting agenda, several items will be considered; 1. For each risk on the risk watch list, the progress and effectiveness of risk treatment actions will be reviewed, and adjustments to Risk Action Plans will be made as needed. 2. Extreme, High and Medium risks for which effective risk treatment has been completed should be reassessed and reclassified, and removed from the risk watch list if appropriate. 3. Medium or Low risks that have changed in status and become important enough to be reclassified as Extreme or High will be included in the risk watch list, and responsibilities and timing for preparing detailed Risk Action Plans will be allocated. 4. Any new identified risks will be considered, and Extreme and High ones will be included in the risk watch list. For each new risk included in this way, the responsibility and timing for preparing a detailed Risk Action Plan will be allocated. Risk Action Plan summaries for all new Extreme and High risks will be included in the risk register and the project Risk Management Plan. 5. Trends and general issues in program risks and risk management will be considered, and any necessary changes to risk management strategies will be made.
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RISK CONTROL Risk assessment Periodic, scheduled reviews of identified risks, risk responses, and risk priorities should occur during the project. The idea here is to monitor risks and their status and determine whether their consequences still have the same impact on the project objectives as when they were originally planned. Every status meeting should have a time set aside to discuss and review risks and response plans. Risk identification and monitoring is an ongoing process throughout the life of the project. Risks can change, and previously identified risks might have greater impacts than originally thought as more facts are discovered. Reassessment of risks should be a regular activity performed by everyone involved on the project. Risk audits Risk audits are carried out during the entire life of the project by risk auditors. Risk auditors are not typically project team members and are expertly trained in audit techniques and risk assessment. These audits are specifically interested in looking at the implementation and the effective use of risk strategies. Technical performance measurement This technique compares the technical accomplishments of project milestones completed during the Executing processes to the technical milestones defined in the project Planning processes. Variances might indicate that a project risk is threatening, and you’ll want to analyze and prepare a response to it if appropriate. Status meetings The purpose of status meetings is to provide updated information regarding the progress of the project. They are not show-and-tell meetings. Risk reviews The nature of risks changes as projects and implementation timeframes change. Regular reviews of risks and risk treatment will be undertaken as part of the normal project management process to revise the lists of Extreme and High risks, to generate new Risk Action Plans and to revise the risk register. 135
The most appropriate way of doing this is likely to be in conjunction with the project's monthly project cost and schedule control system (CSCS) or equivalent reporting, quarterly system audits or equivalent formal review cycle. Incorporating semi-quantitative assessments in the form of risk surveys in the CSCS 'Estimate to complete procedure’ is a practicable way of doing this. The estimate to complete procedure requires managers to think about aspects of the project related to risks and uncertainty, specifically analyses of the work and resource usage to completion, based on historical performance. The risk analysis extends this thinking to more explicit considerations of what problems might occur in the future, and ways of dealing with them. It should be noted, however, that risk surveys will rarely be needed monthly. A six-monthly reporting cycle may be sufficient for small projects; for large projects quarterly reports may be adequate, or surveys may be conducted on an 'as needed' basis. Typical milestone review stages Review Phase
Project Phase
1
Scheme definition, pre-project study
2
Design proposal, plant specification
3
Detailed design
4
Construction and pre-commissioning
5
Commissioning
6
Post-commissioning
Additional formal and more complete risk identification and assessment reviews may be needed. In general, such reviews should be undertaken at key milestones, including: • key planning and design review activities, where there may be significant changes proposed in the project strategy, scope or processes; • at major transition points, such as the start of tendering, contract negotiation, implementation, acceptance testing and commissioning activities, where there are significant changes in the structure and focus of the project and its associated risks; • as part of formal project review processes; • where there is a major change in external circumstances, including any major change in policy, organization or priorities that might impact on the project.
136
Communication and reporting There are many reasons for communicating and reporting the outcomes of a risk management study. • Communication within the project team. Maintaining the consistency and 'reasonableness' of a large risk assessment in a complex project, possibly incorporating the judgments from a diverse team of experts, requires special care. Recording the assumptions that underlie each judgment and decision is important for checking purposes when the results of a risk analysis do not seem right. • Communication with an owner or client. It is important that the end-users understand the risks and trade-offs that must be made in a large project, as they are usually the ones who must pay for risk. • Communication with the providers of finance and insurance support. Funding bodies, whether they are banks, bond holders, equity providers (shareholders), credit guarantors, the finance divisions of the procuring organisations, government funding agencies, or privatesector participants in a public-sector project, all require information about the risks and their allocation and management. • Accountability and auditability. Project managers must be accountable for their decisions. It is important that the risk assessment process is documented in such a way that it can be reviewed, to enable the structure and assumptions to be examined and the reasons for particular judgments and decisions to be identified. • Information source for future projects. The collection of detailed information about all aspects of a project, in a structured fashion that facilitates retrieval, generates a very valuable organizational asset. • Record for post-implementation project evaluation. All organizations should review their large projects after completion, to ensure their objectives have been met and their procedures have been adequate, and to extract the key lessons for improving performance in future projects. Communication and reporting also makes an important contribution to planning processes. • Risk management planning for the key stakeholders. The project Risk Management Plan described in the next chapter provides a high-level focus on risk across the entire project. • Tactical risk action planning. The Risk Action Plans described in the previous chapter provide the basis for tactical action and implementation. 137
• Justification for spending money now or taking a particular course of action. Where significant risk management activity must be taken early in the life of a project, usually directed to risk prevention measures, different funding levels and spending profiles may result. • Communication between the project team and the contractors or suppliers. The project Risk Management Plan and Risk Action Plans should identify the problems and the solutions and convey a detailed understanding of what must be done and why. • Control of risk and risk management activities. Formal project risk management reports specify the criteria for success, the targets and measures used to assess performance, detailed accountabilities for managing risk and the allocation of budgets and resources. They provide the strategic and tactical focus for successful project risk management.
138
Risk Management of International Projects Aleshin (2001) investigated the risk management processes of international projects in Russia. He stated that Russian and foreign publications on project management and business activity pay great deal of attention to the external project risks. These risks include political instability, changeability of tax and customs systems, and significant change in level of currency. The risks are initiated at macro-level and, as a rule, are traditional for countries with a transient economy. At their onset, these risks can produce a strong negative effect on the project. In some studies there are certain recommendations on the ways of escaping external risks.
Figure 43: Interaction between risk breakdown structure and work breakdown structure
For example, American specialists believe that to avoid negative consequences caused by changeability of legislations base, one may include in the contract the so-called "grandfather's clause". In this part of the contract, the authorities should guarantee that all changes taking place in legislation after the signing of 139
the contract do not reflect in the project. However project participants have limited control on external risk management. At the same time, the project analysis and meetings with practical specialists showed that a significant number of risks are initiated by the participants within the project. By contrast, internal risks are more manageable than external ones. Based on the above-mentioned approach, Aleshin (2001) developed a support system for risk mitigation in international projects in Russian conditions as illustrated in Figures (1) and (2). The interrelationship between the risk breakdown structure and the work breakdown structure could be established based on the risk identification of the potential risk events (Figure 1). Also, the interrelationship between the risk breakdown structure and the life cycle of the project could be established in a way similar to the latter one (Figure 2). The time building and revealing of the risk event in the project was defined for each event.
Figure 44: Interaction between risk breakdown structure and project life cycle
140
The proposed risk management support system is based on a firm risk management database. Such a database allows using knowledge about risks efficiency and could be used at different stages of business and project activity as illustrated in Figure (3).
Figure 45: The general area of risk management database application
141
OCCUPATIONAL HEALTH, SAFETY AND ENVIRONMENT (HSE) Responsibility for the safety of employees and contractors usually rests with the person in control of the workplace. This means that outsourcing does not relieve the organization of its legal obligations to identify, assess, control and monitor HSE risks associated with the work to be outsourced, unless the work is carried out on the contractor's site. HSE risks (in terms of accountability) can rarely be transferred by contract. There may also be implications for the health and safety of the organization's own employees from the way in which outsourced work is performed: for example, poor quality cleaning or poor quality equipment maintenance may lead to injury or illness. The HSE performance of tenderers should be a criterion considered when awarding a contract. A further HSE risk relates to employees' lack of familiarity with safety procedures that have now become the prime responsibility of a contractor. For example, critical safety procedures may change to comply with a contractor's normal practice; this may mean that internal staff need to be familiar with, and comply with, several different procedures depending on the contractor. This is a particular issue where the organization has a competition policy of not awarding multiple contracts to a single supplier.
142
HAZARD AND OPERABILITY STUDY (HAZOP) A Hazop study is a common identification technique used to examine proposed systems, equipment and procedures systematically and in detail. Its objective is to identify potential hazards to people, the environment, the plant or operations and the proposed methods for their control. It particularly examines the effects of deviations from the design intent by asking a series of questions based on prompts or guide words: for example, 'High pressure, how might it arise? If it did arise, what would be the potential consequences?' A Hazop study is usually conducted when the design for a proposed system, plant or production unit is at or nearing completion. Piping and instrument diagrams (P&IDs), sometimes termed process and instrument diagrams, are usually available, the control strategy including start-up and shutdown has been defined and the basic operating procedures have been specified. Like the general risk management process described in earlier chapters, a Hazop begins by defining a set of key elements. Usually these are the main process lines or flow lines through sections of the plant, identified from the P&IDs, and the analysis begins as soon in the design process as they are available. Key elements could also be identified from process flow sheets if the Hazop is being conducted at an early design stage, as in a concept hazard analysis or preliminary hazard analysis. Preferably the study is facilitated by an experienced independent person and includes appropriate management, design, operations and maintenance personnel with a direct involvement in the project. The process works systematically through the design, examining each item on each flow line in detail. For each item, the facilitator asks a series of questions based on guide words. These are designed to stimulate the analysis team to think about how situations described by the key word might arise - possible causes or sources of risk. The flow line is examined for all possible deviations relating to each guide word. For each potential deviation, the team identifies the cause of the deviation and its consequences for the plant as a whole. Assessments of the probability and severity of each potential deviation may be used to set priorities for management action. The elements are usually the specific flow lines, process flows, process steps or equipment items on the P&IDs. The process should be systematic And complete, addressing all the elements and all the guidewords.
143
Technique
Information required
Approach
Deliverable
Preliminary design information such as basic process flows and conditions and a list of the main hazardous materials Preliminary design information
Structured facilityspecific list of what-if? questions applied systematically across the facility Use generic checklists systematically across the facility
List of hazards inherent in the proposed process and materials
Hazop study (IEC 61882)
Detailed design information including P&IDs or equivalent, control and safety system strategy
Chazop study
Detailed design information including P&IDs or equivalent, control and safety system logic and sequences
Detailed systematic review of each process step, process line or equipment item, explicitly examining deviations from the design intent Detailed systematic review of each control function, explicitly examining deviations from the design intent
Preliminary Hazop study
Preliminary design information including process flow diagrams and most P&IDs (but still in draft), combined with vendors' typical drawings
SIL determination study (IEC 61508)
Basic design information including P&IDs or equivalent and control strategy
What-if analysis
Checklists
144
List of hazards, but may miss hazards specific to the particular application. More powerful when used in combination with a “What if analysis” List of detailed hazards, their consequences and proposed rectification actions
List of detailed hazards associated with the control system and proposed rectification actions Systematic review List of hazards of each major and proposed process step, rectification process line or actions equipment item, explicitly examining deviations from the design intent Often performed List of ranked as an add-on to a hazards and the Hazop study, level of rating the risk protection associated with required to
Project: Kiln Project
Section: Coal handling
Drawing: 123-1Rev A, 456 Rev C
Date: 12 December Revision: Draft
each potential hazard without any proposed protection system
reduce each hazard to tolerable levels
FMEA
Basic design information including P&IDs or equivalent, controls and safety system strategy; if being applied to a single problem area, a detailedSystematically examines each item and determines how that item may fail and the consequences of a failure breakdown of the components
Systematically examines each item and determines how that item may fail and the consequences of a failure
Detailed list of the hazards caused from internal failures; may miss issues associated with human systems and external events, but can be applied with care to activities
FMECA
As for the FMEA, plus an agreed set of criticality (risk) rating scales
The hazards identified by the FMEA process are rated according to their criticality (risk)
Detailed ranked list of the hazards arising from internal failures
145
Node
Guideword
Causes
Consequences
Safeguards
Action
Manager
Raw coal Position unloading
Ignition from Coal dust truck or front- explosion end loader engine
and
Design means of controlling where dumping occurs. Western door must be closed at all times when coal is being delivered
Raw coal Movement unloading
Coal left in Undisturbed coal corners for long can self-ignite periods
Consider means of keeping corners free of coal for longer periods.
Comments and Status
Ensure no loader movement when there is a dusty enviromental Raw coal High unloading Temperature
Coal delivered Undetected hot and fire smoldering
Raw coal Low unloading Temperature
Moisture Big lumps going Front-end Screen on top of raw content in coal into the plants loader will coal hopper. freezes break up some lumps
Raw coal Maintenance unloading
No personnel doors in the roller doors and controls are outside overload
Raw coal Load hopper
coal
Consider thermocouples in the concrete to detect high temperature and/or a manual survey
Person unable to egress from coal storage if doors closed
Consider operational philosophy of restricting access to the coal store
Spillage
Design some control to indicate when not to dump into the hopper.
Raw coal Contamination Rags, concrete, Contamination of Regular Screen on hopper etc. In coal feed into the plant visual hopper. inspections of the hopper
146
top
of
.
Design requirements
Define risk
Define causes
Define consequences
Response
Yes
Significant hazard
Figure 46: HAZOP model
147
No
Accepted
FAULT TREES Fault tree analysis is an important specialist technique for risk assessment, with significant extensions into quantitative aspects of risk analysis. It is a process, derived from systems engineering, for identifying and representing the logical combinations of causes, system states and risks that could lead to or contribute to a specified failure event, often termed the top event. Fault tree analysis provides a structure for estimating the likelihood of the top event by tracing back the causes until it has identified simple events or component states for which the likelihood can be estimated. The analysis is continued until a set of base events is reached, sufficient to understand the nature of the failure processes and how they may be managed. Typically the top event is a system failure or undesired outcome, and the process attempts to identify the possible causes that might lead to the undesired outcome and its frequency. Fault trees are constructed using two types of logical connection, 'AND' gates and 'OR' gates. Figure 17.4 shows a simple example of how a failure in a pressure vessel might arise and be represented as a fault tree. An AND gate is used when a fault tree component and another component must both be in the required state for the event to propagate; for example, the pressure vessel would only fail if there were both an over-pressure and the relief valve did not open. An OR gate is used if the failure event is propagated if either one component or another component is in a particular state; for example, the relief valve might fail to open if there were a failure of the safety valve itself in a closed position or if the isolation valve were closed manually by an operator. Pressure vessel failure
AND
Pressure exceeds limits
Relief valve fails to open
AND
OR
Control valve fails close
Pump fails to trip
Safety valve fails close
Figure 47: Fault tree model 148
Isolation valve closed by operator
Limiting factor cutter dredge production Hydraulic reclamation Construction Cutter production Cutter power
Pumping
Side winch Power
Circumstances
Suction
Personnel Crew
Delivery
Staff Planning
Max. swing speed
Figure 48: Dredging case study
BENEFITS OF ENVIRONMENTAL RISK MANAGEMENT Project plans and appraisals should consider environmental risks, their impacts and their treatment. There are many reasons why organizations undertake environmental risk management as part of their project management activities. • There is a regulatory requirement for it. In many jurisdictions, regulators require formal environmental impact studies and reports, to ensure environmental risks have been identified and adequate treatment measures to mitigate them have been included in project plans. Often the mitigation measures become a condition for project approval and licensing. Mitigation activities are likely to extend over all phases of a project and the whole life of the asset created by a project, from design and construction through operations and on to close-down and site rehabilitation. • There is an ethical requirement for it. Many companies have codes of ethics and environmental conduct that require appropriate priority to be given to minimizing environmental damage and harm. This is part of the ‘good citizen’ role of companies. Environmental performance may also be included in the organization's triple-bottom-line and balanced scorecard reporting and monitoring systems. 149
• There is an economic reason for it. Identifying environmental risks and mitigating them early in the life of a project is usually far easier and cheaper than having to rectify problems and clean up a harmful environmental release. As well as direct financial benefits, avoiding environmental problems reduces the amount of management time and distraction involved in dealing with them, reduces disruption to operations and, in the extreme case, avoids regulatory penalties and costly litigation. • There are social and community reasons for it. Most projects have many stakeholders with an interest in the project's outcomes and its wider effects. Sound environmental risk management promotes better communication with stakeholders, better community understanding of environmental costs and benefits and greater transparency of process. In some jurisdictions, explicit community consultation is a formal requirement, and in many projects it would be strongly recommended anyway without the regulatory imperative. Overall, good environmental risk management makes good business sense. Systematic consideration of environmental risks as a component of business risk assessment helps identify key uncertainties and areas where lack of knowledge may be critically important to estimates of potential business performance. In extreme cases, environmental risks may be a reason for not proceeding with a project as conceived or at all. Risk assessment may also be used to set remedial action priorities, where past activities may not have met current environmental guidelines.
Environmental Risk Management Risk may arise from an event, an action or a lack of action. Risk to the environment can be in the form of stresses caused by human activity, or inactivity. This risk might manifest itself as a threat, which can lead to degradation of the environment or loss of sustainability Conversely, risk can also lead to the enhancement of the environment when a risk management process is used to identify opportunities and they are pursued. When reviewing environmental risks and the actions that may be taken to manage them, the threats and opportunities that an activity, service or product may present should be considered. Opportunities and threats are both important parts of risk management, as assessing the opportunities on offer may influence the prioritization and subsequent treatment strategies.
150
Environmental Management Systems The basis and much of the information for the context stage may often be found in the environmental management system (EMS) that many organizations maintain, consistent with the ISO 14000 series of environmental standards. Risk management is an integral part of such an EMS. ISO 14000 requires organizations to maintain an 'aspects and impacts register', which is equivalent to a risk register, and to maintain formal environmental risk management practices. Whether the EMS drives risk management or risk management drives the EMS may not matter much - the important thing is that the processes work together to generate better environmental and project outcomes.
151
Elements Principles
Concepts that should be included Possible environmental incidents must be anticipated, and managed. Proactive and diligent risk management is essential. Risk management forms a key part of responsible environmental policy. It is also good business practice.
Objectives
Identify and characterize environmental risks. Determine priorities for the introduction of effective risk management actions.
Responsibilities Managers responsible for operations that may present a potential risk to the environment should review their operations to determine whether or not they represent a significant risk, and take appropriate risk management action to reduce both the organization's and their own exposure.
Criteria and Consequences It is common to think about environmental risks in terms of events with potential environmental consequences, and to restrict the assessment purely to consequences for flora, fauna and the natural environment. However, this is often too narrow a perspective, and business impacts may be as important as environmental consequences in many cases. An appropriate range of consequence criteria should be included in all risk assessments, including environmental risk assessments. For example, the following table shows a holistic set of environmental consequence criteria adopted by the Australian Department of Defense as part of its defense EMS risk management framework. In this case, environmental and related community and heritage criteria alone would be insufficient to reflect the range of cones- quinces of interest to defense managers and environmental managers. Similar concerns arise in more obviously commercial businesses.
152
Example of environmental consequence criteria Criterion
Notes
Capability and Impact on the ability of the Australian Defense Force (ADF) to protect Australia and fulfill its national security obligations. Impact on the ADF's mission ability to train and equip for war and for the conduct of peacetime operations. Impact on the ability of defense to develop its capability as detailed in the Defense White Paper. Environment
Impact on the environment, including contamination, damage to flora and fauna, fire, noise, soil damage and erosion, greenhouse gas emission. Environmental management in the strategic context of defense business.
Community and sustainability
Impact on our ability to create a sustainable environment for the future, including depletion of resources, excessive energy use, long-term damage to the environment.
Safety (staff Impact on the physical well-being of military and defense employees, communities in defense regions and the public in general. and public) Compliance and reputation
Impact on defense’s reputation as a world leader in managing the environment, political and media attention to environmental matters, community concerns or actions over defense environmental management. Compliance with environment and other regulatory requirements and the impact of failing to comply. Short-term cost of prevention vs. long-term cost of recovery.
Financial
Monetary impact on defense, the Government and other stakeholders.
153
Elements based on issues and environmental aspects Environmental Issues
Environmental Aspect
Sustainable management Land use of ecosystems Interaction with marine environment Interaction with aquatic environment Flora and fauna interaction Energy use
Natural resource consumption
Water use Waste generation Soil and water contamination Waste treatment and disposal
Pollution prevention
Air emissions Noise vibration and electromagnetic radiation generation Climate change and ozone depletion
Use of ozone depleting substances Greenhouse gas emissions
Stewardship
Procurement and acquisition infrastructure development and support Stakeholder management Business practices Heritage management
Elements based on general functions Function
Function continued
Ablutions and sewage treatment
Landfilling
Accommodation
Office administration and miscellaneous
Dangerous goods
Special functions
Dining areas and kitchens
Vehicle servicing
Engineering and building
Vehicle washing
Grounds maintenance
Warehousing
Hospital and first aid
154
Identification of Environmental Risk Risk identification for environmental risk assessment is often based on general structures relevant to the way in which hazards may arise and affect things in the surrounding environment. For example, it is often useful to consider that a risk exists if there is: • a hazard or potential source of harm; • one or more targets susceptible to the hazard; and • one or more pathways for the source to affect the target. Sources may be identified by site reviews, process reviews, hazard inventories and incident monitoring, some of the tasks that may be mandated by regulators as part of environmental impact assessment processes. • Site reviews should consider structures (buildings, surfaces, drainage systems), storage facilities for hazardous substances, including wastes, and process equipment. • Process reviews should consider potential hazards associated with processes, process streams, materials and by-products, and transport and storage systems. • Hazard inventories should list all potentially hazardous materials on or near the site. • Incident monitoring should record and analyze previous incidents of non-routine releases of hazardous materials into the environment, or nearmisses where a release was possible but avoided. Chemical hazards are often classified according to their potential effects. It is often useful to distinguish between acute hazards (those where the event itself poses the primary risk directly) and chronic hazards (where there are long-term effects or long-term accumulations in the environment). Particular characteristics of note may include: • acute Eco toxicity - immediate impacts, e.g. death; • chronic Eco toxicity - long-term damage, e.g. ability to reproduce; • mutagenicity and teratogenicity - the potential effects on offspring due to mutations or congenital malformations; • persistence - the length of time a release will remain hazardous before decaying; • bioaccumulation and bio concentration - the potential for material to accumulate and concentrate within components of the ecosystem.
155
Physical hazards are usually associated with the industrial operations presenting potential for harm to the environment. These may include fire, explosion, noise, flooding or dust. To identify receptors, survey the environmental setting and neighborhood to identify targets that may be at risk. Where appropriate, discuss the initial list with regulatory authorities and other groups with interests in potential receptor categories. Examples of receptors include: • population areas; • farm land and fisheries; • water resources, including ground water and surface water; • park land and recreational areas; • specific ecosystems, environment;
particular
species
and
the
wider
natural
• rivers and lakes; • geological features and features of scientific interest; • historic buildings and ancient monuments; and • sites of cultural or religious importance to indigenous groups. Potential sources of risk should be considered systematically against each potential transport pathway to determine which are relevant to each identified hazard. Sources, pathways and receptors are sometimes described in terms of the risk scenarios that may result in hazardous incidents. Tools for developing and classifying risk scenarios include: • failure mode and effect analysis (FMEA); • event trees; and • project hazard studies.
156
Risk Treatment Strategies The same kinds of risk treatment options are available for environmental risks as for other project risks: avoidance, reduction of consequences and likelihoods, transfer and acceptance. For environmental risks, examples of physical treatments include: • design and engineering solutions; • bunds, cut-off drains; • reduced hazardous inventory; and • removal of vulnerable targets from potential impact areas. Examples of procedural treatments include: • preventive maintenance; • monitoring, sampling and alarms; • risk-based inspections; • emergency plans; • formal operating procedures; and • incident and near-miss reporting. Approaches to Environmental Risk Management While the approaches to environmental risk management often have many similarities, the terminologies and underlying philosophies may vary. For example, the following table shows the terms used in the US Environmental Protection Agency Guidelines, showing the similarity in the basic steps. The approach to regulatory decision making in some jurisdictions seems to envisage a clear separation of responsibilities between the risk identification and analysis activities - viewed as a more-or-less scientific and value-free pursuit - from the risk treatment or risk management activities involved in making decisions, where a broader range of political criteria and values are not only appropriate but necessary for policy setting.
157
Comparison of the base process with the US EPA Guidelines Reference process
US EPA Guidelines
Establish the context
Planning Problem formulation
Identify the risks
Analysis
Analyze the risks
Analysis
Evaluate the risks
Risk characterization
Treat the risks
Risk management decisions
Monitor and review
Iteration and monitoring
158
Appendix A:
Risk Aspects
Risk aspects of power projects (Lam-1999) Project name / location •
Akkuyu Power Plant, Turkey
Risk mitigation measures
•
Electric authority undertook to purchase power from the concessionaire at fixed price
Residual risks
• • • • •
•
Dabhol Power Plant, India
•
Central government counterguarantees that State Electricity Board pays for electricity supplied, State Electricity Board commits to take 900/o of power even in non-peak hours, Free repatriation of dividends and interest on foreign equity and loans, Protection from forex fluctuations, Guaranteed return on equity for a specified minimum availability Tax holidays Multilateral agencies (IFC, CDC and ADB) invested equities and provided loans, Electricity authority undertook to supply coal at no cost to concessionaire, Electricity authority undertook to construct transmission facilities Bonus for early completion, Capacity and energy fees payable in USS and pesos
•
The government had issued guidelines for 3 other projects as follows: • Guaranteed return on equity, • Guarantee against currency depreciation. • Guarantee payment by power purchasers
•
• • • •
•
Pagbilao Power Plant, The Philippi nes
• • • • • •
•
Karachi Power Plant, Pakistan
•
• • •
• • • •
Risk consequences
Absence of sovereign guarantee on: Repayment of external debt, Purchase of minimum amount of electricity, Exchange rate, Convertibility of revenues into hard currencies Fuel (liquidified natural gas) has to be imported with bureaucratic procedures for clearances and approvals, Many locals are not used to paying for power supply making it politically awkward to enforce collection, Lack of competitive tendering aroused skepticism of accountability Environmentalists' objection Allegedly high capital cost and tariffs
•
Environmentalists' objection Land acquisition and compensation problem Delay in construction of transmission system. Differences in the interpretation of concession contract
•
•
• • • •
•
•
• • •
• •
Government insisted on the use of local coal, which investors feel uncertain as to quality and quantity. Slow progress of geological survey offered little help to verify local coal reserve, Promoter chose site near coast for import of coal. But government objected
159
•
•
Export credit agencies unwilling to provide guarantee for proposed investments or export credits, Sponsors and lenders unwilling to proceed
1st phase changed to use local naphtha as f fuel Legal challenge by trade union body (cleared), Successive State governments reviewed contract, nearly scrapping it, Work interrupted for over 1 year before being revived in Dec., 96 after a compromised reduction of capital cost and tariff State government obtained right to take a 30% stake in the project
Legal battle challenging the proper issuance of the Environmental Compliance Certificate, Injunction sought by local groups against the project agreement on ground of public interest, public safety and health, 160/o of project cost spent on pollution control, Delay start-up Expansion plan at odds for fear of rekindling opposition from local residents Alternative inland site locations offered by government, but these require substantial investment in building connecting roads, Impasse affected progress of negotiation
Risk aspects of expressway projects project name/location (Lam-1999) Project name /location •
North-South Highway, Malaysia
Risk mitigation measures • •
•
Second-Stage Expressway, Thailand
• • • • •
•
~ Highway, China
• • • •
Government guarantees to reimburse concessionaire for traffic volume shortfall, foreign exchange and interest rate losses, Obligatory contribution to equity by the 48 participating sub-contractors, effectively providing completion incentives
Government willing to share revenue from existing toll road system, A decree was issued to facilitate acquisition of land, Corporate income tax relief, Tax exemptions on dividends, Upon adversities in interest rates, economic conditions, relocation of utilities, government interferences, unanticipated ground conditions, force majeure, etc., concessionaire would be entitled to adjust revenue sharing proportions, toll levels and extension of concession period Project guaranteed by GITIC, the investment arm of the Provincial government, People's Insurance Co. of China covers political risk of policy change and nationalization, No dividend or repayment of sub-ordinated loans to be made until Performance Test criteria are met, Bonus clause for early completion
Residual risks •
Difficult terrains: the highway construction ran through abandoned tin mines with unknown conditions, jungles, mountain and swamps, • Design changes to overcome unexpected technical difficulties, • Inflation on cost due to construction boom in Malaysia, • Opening date brought forward by 1 year to ease pressing congestion, • Allegation of political patronage Disputes broke out on the following issues: • revenue sharing scheme, • whether concessionaire could collect tolls and manage traffic, • which party was to pay VAT, • which party had right to develop land under elevated sections of the expressway, • reduction of contracted toll by one-third
Risk consequences • •
• • • • • •
• • • • • •
Financial close delayed for 2 years due to Tiananmen event in 1989, The land acquisition process (8000 acres) took 6 years and US$132 million to complete, The 16 km Boca Tigris Bridge, which forms in essential link of the entire route, was under threat of take-over by competitor, Design changes and abortive work (e.g. Widening span of bridge already constructed), Depreciation of local currency, Post-completion traffic management not fully in concessionaire's control
160
• • • • •
Cost overruns entailed additional loan and equity financing, Completion 15 months ahead of schedule brings additional toll revenue (upside result)
Banks suspended loan in 1993 halting project, Completed stretch of 20 km closed for 5 months due to row, Government obtained court order to force open completed stretch, Concessionaire claimed that US$80 million was owed from the defunct revenue sharing agreement, Major share-holder, Kumagai Gumi, pulled out by selling its 65% share to Thai contractor and hankers in 1994, Shock-wave sent across the international financing community, posing questions of financiability of subsequent projects Delayed commencement but Phase 1 was opened to traffic earlier than agreed with financiers, Developer applied for doubling of toll due to depreciation of local currency, Frequent accidents within the first 2 months of operation, Pilferage of road signs and trespassers, Non-payment by local authorities' vehicles, leading to accounting problems and revenue loss
Risk aspects of bridge, tunnel and airport projects (Lam-1999) Project name /location •
Prince Edward Island Bridge, Canada
Risk mitigation measures •
•
•
•
Channel Tunnel, between Britain and France
•
•
•
•
Residual risks
Construction cost fully financed in Canadian capital market through the use of real rate bonds, which are fully indexed to inflation with a guaranteed rate of return, Security package to guard against delay and cost overruns (e.g. US$141 million performance bond and US$14 million labor and material payment bond), Government subsidized US$29 million over the entire concession period, which represents the avoidable cost of running the replaced ferry service
•
Guarantee by 2 governments against political interruption or cancellation, Guarantee that governments would not facilitate any 2nd link before the year 2020, Independent Project Manager (Maitre d'Oeuvre) monitored progress and quality, Construction contracts were designed to control cost: Tunneling-target price contract whereby contractor would be rewarded for keeping cost below target or penalized for excess. Terminal works-lump sum
•
•
•
•
•
• •
•
Terminal 1 and 2 of Toronto International Airport, Canada
•
•
•
Government would not develop any other airport facilities within a 75 km radius until the terminals are processing 33 million passengers a year, Partial deferral of lease payment to the government (interestbearing). Assignment of lease with an existing major air carrier
•
• • •
Risk consequences
The project would result in redundancy of 500 ferry workers, who staged strong objection, Opposition from fishermen and environmentalists alleging that ice build-up in the strait would harm valuable lobster and scallop business
•
Massive design changes and delays resulted from escalation of safety, security, and environmental requirements demanded by the two governments. Contractual disputes between Euro tunnel and TML, its contractor, Tunneling machines were designed to operate in dry and self-supporting chalk based on site investigation and previous records but it turned out to be a lot wetter and more fissured causing cave-in Optimistic estimate of potential market beyond Channel Tunnel's hinterland, Stiff competition from ferries and airlines
•
Concession contract signed weeks before an impending general election, Lobbying to obtain the concession was challenged. Political patronage was alleged. No cancellation clause was put into the concession contract dealing with compensation in case of default
•
•
• • •
•
•
•
•
•
161
Over 70 environment impact assessment studies were carried out since 1986, resulting in prolonged gestation period, Court hearings were conducted to decide contest from ferry workers and fishermen, which might have put project to a halt
Cost overrun entailing refinancing, Substantial claim from TML, which is pending assessment Several fatal accidents during construction, Shuttle train service opened in 1994, 18 months behind schedule, Estimated revenue not realized in 1st year of operation (25% under-capacity), Post loss for 1st year, leading to suspension of interest payment on its junior debts in Sept. 95 with plunge in share prices. Re-structured debts with financiers.
The contract was cancelled by the incoming government after a 1-month review in 1993, In 1994, a new bill was proposed to bar the developer from claiming forgone profit and lobbying fees. The bill was nevertheless held up indefinitely after much debate, In 1995, the court ruled that the government was in breach of contract and the developer could proceed with lawsuit for damages. Terminal then came under Local Authority
Risk aspects of rail system projects (Lam-1999) Project name/location •
Tanayong Light Rail System, Bangkok, Thailand
Risk mitigation measures • • • • •
Concessionaire granted 8year corporation tax holiday, Fully exempted from duties on imported machinery and materials, Route follows government's right of way, hence little land acquisition problem. use of proven elevated rail technology, no revenue sharing or royalty payable
Residual risks • • • •
• •
•
Skytrain project, Bangkok, Thailand
Original contender 'Lavalin' put forward the followings to lure concession: • • • •
•
Combined road and rail system in Bangkok, Thailand (BERT)
•
•
• • •
interest-free loans from export-credit agencies, international banks acted as guarantors, lower fare structure and soft loan terms, repay Thai government investment earlier than competitor Concessionaire (Hopewell Thailand) granted property development right (more than 900000 m2) along route, proposed route mostly follows existing rail/road, hence little land acquisition problem, granted 8-year tax holiday on profits, exempted from withholding tax on interest from overseas bank loans, option to extend concession for 20 years
• • •
• • • •
•
Risk consequences
Public objected to the use of the popular Lumpini Park as depot. Alternative depot competed by others, Change of governments incurred stop-go hiccups. Government wanted system to go underground within 25 km of city center as a result of environmentalists' campaign. Train fare as sole source of project revenue, Financing made difficult by the row of the 2nd Stage Expressway Proposed route required more land acquisition than the other two projects. Major contractor-member of the Lavalin consortium unable to participate at last stage, Financiers reviewed credit rating of Thailand due to frequent coups, making it difficult for Lavalin to obtain financing within time limit set by Thai government
•
Conflicts with other routes and state railway. Government wanted part of route to go underground on environmental ground. Government increased rent for pre-casting yards. Threat of contract review by successive new governments and military coups hampered country's credit rating, Depreciation of Thai Baht caused by speculators in July, 1997
•
162
•
• • • • •
•
• • •
• •
Relocation of depot entailed 4 additional stations and resubmission of turnkey bids, Cost would be doubled and program extended by 3 years if system forced to go underground, • 21 km of the route had to go underground, Duplicated roles of government ministries created conflicts, Rider ship becomes critical for profitability, Financing finalized 15 months after construction had begun Cost increased by US$ I billion during the 6-year hiccup and delay, Lavalin's contract declared void by the Thai government in 1992; Bangkok Land chosen as the next contender but deal also foundered, Government took over construction of entire subway with hope to privatize operation Increased construction cost of interfaces; Protracted negotiation and delays in design approval and land resumption, Government allowed the system to remain elevated, Hopewell had to double equity contribution over contract requirement to show commitment, Share price of parent company fluctuated, Contract cancelled
Risk aspects of telecommunication and process plant projects (Lam-1999) Project name /location •
Bangkok Metropolitan Telephone System, Thailand
Risk mitigation measures • •
• •
•
Buenos Aires Water Treatment. Argentina
•
• •
•
Residual risks
State telecom body (TOT) assists Telecom Asia (Concessionaire) to obtain all necessary government consents, TOT responsible for customers' service and bill collection. Telecom Asia can use existing TOT facilities
•
Legislation to ensure payment for water supplied (45% was lost prior to privatization) and to permit cutting off service in case of nonpayment Free convertibility of foreign currency. Quality requirements for both potable water and sewage effluents set to tighten gradually very 5 years and not immediate upon privatization. Water rates to be reassessed every' 5 years to adjust for cost inflation
•
•
•
•
•
The equipment supplied by Telecom Asia must integrate with TOT's existing network, Telecom Asia is obliged to make changes to its telephone system to match up with potential changes to the TOT network, Telecom Asia bears the cost of expanding TOT's exchange to suit the addition of telephone system Early retirement scheme of 4000 (50%) redundant employees was a sensitive issue, Contention with regulator on the degree of independence of operator, frequency of reporting, and the reliability of information. Pressure to impose priorities was exerted onto the operator
163
Risk consequences •
•
• • • • •
Coup broke out in April, 92 resulting in change of government during which time the deal was negotiated, Another new government was formed in July, 1995 and reviewed( the concessionaire's plan to extend the network by 600000 fixed line~ Telecom Asia committed to pay royalty of 16% of its phone line revenue to the government Retirement scheme entailed US$90 million severance payment in 6-month time, Bid evaluation and award delayed by 8 months, Interruptions in services due to unexpected power break and planned repair works. Cash deficit in the 1st year of operation
Appendix B: Statistical Measures
164
165
Appendix C: Risk Forms Risk Log Reference
Description
Probability
Potential Impact
166
Response
Reported by
Date
Interim project risk report Project Report No.
Date:
Initial / Previous estimate
Current estimate
Base estimate
Confirmed costs
Confirmed allowance
Revised risk allowance
Expected outcome
Anticipated out-turn costs
Target completion date
Contract completion date
Risk allowance
Approved extension
Expected completion date
Risk allowance Anticipated completion
Risks to be expended
Average allowance
Notes:
Signature:
For:
167
Maximum allowance
Risk identification form Project Risk Reference Description
Date Identified
Identified by Likelihood of occurrence Potential Impact Risk Exposure Response Assessment Likely time Optimistic Pessimistic Likely cost Optimistic Pessimistic
Low / Medium / High Low / Medium / High Impact area Acceptable/ insignificant/ significant/ critical/ unacceptable Ignore/ Manage/ Share/ Transfer Items affected
Description
Secondary risks Reference of secondary risks Responsibility Detailed assessment Prepared by: Signature
Yes
No
By: Approved by: Signature
168
…………..% Cost/ Time/ Performance
Risk Register Ref.
Description
Trigger
Interdependencies Refs.
Probability
169
Impact
Response required
Response implied
Owner
Status
Date
Comments
Appendix D: Probabilistic Distributions
170
171
172
173
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