The main risks that the parties may face during the pre-commissioning period are: (1) completion risks - the project cannot be completed at all; (2) construction delay risks - the project cannot be delivered according to the agreed schedule; (3) cost overrun risks - the actual construction cost exceeds the original cost estimates; and (4) performance risks - the project fails to meet the performance criteria at completion. The project company, its contractors and suppliers, can in certain cases create risks. For instance, construction cost overrun and delay in completion may be the result of inefficient construction practices, waste, insufficient budgeting or lack of coordination among contractors. Failure of the project to meet performance criteria may also be the result of defective design, inadequacy of the technology used or faulty equipment delivered by the project company's suppliers. However, some of these risks may also result from specific actions undertaken by the LGU or by other public authorities. Performance failures or cost overruns may be the consequence of the inadequacy of the technical specifications provided by the LGU during the selection of the concessionaire. Delays and cost overruns may also be brought about by actions of the LGU subsequent to the award of the project (delays in obtaining approvals and permits, additional costs caused by changes in requirements due to inadequate planning, interruptions caused by inspecting agencies or delays in delivering the land on which the project is to be built). General legislative or regulatory measures, such as more stringent safety or labor standards, may also result in higher construction or operating costs. Shortfalls in production may be caused by the non-delivery of the necessary supplies (e.g, power or water) on the part of public authorities.
Other risks that occur in the pre-commissioning period include delays in project completion due to force majeure and the bankruptcy of shareholders and suppliers.
Table 2-5: Pre-Commissioning Period Risks and Possible Coverage Mechanisms
Type of Risk | Definition | How can it be covered? |
Completion risk | • The project cannot be completed at all or cannot be delivered according to the agreed schedule (completion risk); | This risk can be covered on three levels. The primary means of covering completion risk is through a turnkey contract. This type of contract stipulates liquidated damages for delays in construction period. It is important that the price of turnkey projects be higher than usual contracts, in order to compensate the builder for taking on the completion risk |
Cost overrun risk | • Construction cost exceeds the original estimates (cost overrun risk); | |
Performance risk | • The project fails to meet performance criteria at completion (performance risk). | The secondary level of coverage by direct management of the project company, and indirectly by equity investors. Equity is often eroded by delays or cost overruns and is not covered by damages from the contractors. The tertiary level of risk coverage is through performance bonds. |