6.4.1  Direct and indirect consequences of risk

The consequences of risk can be either direct or indirect. Direct consequences include time and cost overruns over the initial base costs used in the Raw PSC. Indirect consequences arise from the interaction between risks, where the occurrence of one risk has flow-on implications for other aspects of the project. When identifying the consequences of a particular risk, the potential interaction between risks needs to be considered. This is particularly relevant where the risk would delay the critical path and has a flow-on effect throughout the project.

For example, when considering construction risk, the possible flow-on effects, or indirect consequences, could include:

•  the cost to government of maintaining existing (and often more expensive) infrastructure or services;

•  increased operating and management costs; and

•  increased maintenance costs over the term of the project if the cost of key raw materials unexpectedly increases (focus on whole-of-life costing).

Generally, all these costs should be included in the cost of the underlying risk that causes the interaction. However, care should be taken to avoid double counting. This may arise where a risk would be transferred under a public procurement, for example, design and construction risks under a fixed price or turnkey contract and flow-on effects under liquidated damages provisions. In this case, if these risks are included in the contract price specified in the Raw PSC, they should not be double counted by inclusion in the risk components of the PSC. Table 6-2 provides a list of typical direct consequences of particular risks.

Table 6-2  Direct consequences of risk

Risk category	Direct consequence
Commissioning risk	Additional ramp-up costs, cost of maintaining existing infrastructure or providing a temporary alternative solution where this leads to a delay in the provision of the service
Construction risk	Additional raw materials and labour costs, cost of maintaining existing infrastructure or providing a temporary alternative solution where this leads to a delay in the provision of the service
Demand (usage) risk	Reduced revenue based on lower throughput
Design risk	Cost of modification, redesign costs
Environmental risk	Additional costs incurred to rectify an adverse environmental impact on the project, incurred from the construction or operation of the project or pre-existing environmental contamination
Financial risk	Additional funding costs for increased margins or unexpected refinancing costs
Force majeure risk	Additional costs to rectify
Industrial relations risk	Increased employee costs, lost revenue or additional expenditure during delay in construction or service provision (post-construction)
Latent defect risk	Cost of new equipment or modification to existing infrastructure
Operating risk	Increased operating costs or reduced revenue over the project term
Performance risk	Cost of failing to comply with performance standards
Change in law risk	Cost of complying with new regulations
Residual value risk	Lower realisable value for underlying assets at end of project term
Technology obsolescence risk	Cost of replacement technology
Upgrade risk	Additional capital costs required to maintain specified service above the level included in the Raw PSC
Maintenance risk	Increased cost of repairs above the level included in the Raw PSC

Note that the consequences associated with a particular risk may also change over time. For example, the consequences of technology risk are likely to increase over time due to technical obsolescence, but also will be influenced by the cyclical replacement of equipment (e.g. where software is updated, or replacement equipment is installed). Further, the replacement cost of equipment may change over time.

A useful tool for identifying the consequences and financial impact of risk is a risk matrix. A comprehensive risk matrix should be more than an indication of whether each risk should be transferred, retained or shared. It should also identify the main consequences, financial impact and potential mitigation strategies for each risk. This allows the risk matrix to serve as a reference point for valuing risk in a PSC.

It is useful to separate the different causes and consequences of each risk for two reasons:

•  different consequences may have a different probability of eventuating - typically, more severe consequences have a lower probability of occurring; and

•  it may be optimal to allocate different causes for the same risk between the parties, based on their ability to manage it at least cost.

This process is performed for each risk to complete the risk matrix. The entire process should be thoroughly documented to ensure an adequate probity trail exists to justify the risk valuation and allocation, and to allow for future review of the process. Risk Allocation and Standard Commercial Principles should be referred to for guidance on the development of a risk matrix.