Risk management is one of the most important components when managing project finance. In most projects, stakeholders will put together a risk taxonomy where they will identify the risks and allocate the risks to the people best able to manage them. We generally start by thinking about risks in a chronological basis.
A chronological approach means following the lifecycle of the project. The major split is between the construction phase and the operational.
In the construction phase, an obvious risk is higher costs. However, there will be more knock on impact. There are also delays in the revenue going forward during the operational phase, once we hit the operational phase, some of the big risks are that the original forecasts don't come true, and this could be the case for lower traffic than expected for a tunnel. Raw materials might be more expensive than expected, and for a refinery, this would be very damaging. All these things are going to affect cash flows. This will then affect the ability of the project to repay the debt, and in turn, it'll affect the ability to create returns for the equity holders.
Some risk schools cover both the construction phase and the operational phase. Technology is a good example. This could affect both phases equally, if we take a look at the overall cash spend in the project, you can see that the low point, typically in the early years of the project, usually at the end of the construction phase. However, risk tends to be heightened partway through the construction phase a bit earlier, and that's because you don't have a working asset. You can create revenue with. You have a half-built project. In the graph we're seeing, although you've got the low point in terms of cash spend in year three, actually by then, you should have an operational asset that's producing income. This will be reflected by the negative cash position, which starts to reduce or go upwards from that point onwards. But in terms of risk, if you get to the end of year two, so a bit earlier than the aforementioned cashflow point with a partially complete project, and then all of a sudden things stop, this would be a huge problem. Because by then you spent a large amount of money, but you don't have anything to show for it.
