What is the risk profile of infrastructure projects?

The crucial elements in the financing of infrastructure investment is first assessing the severity of each risk and then identifying the party in the best position to manage a risk. The three broad stages in an infrastructure project with different risk profiles and financing requirements may be identified as follows: Development risk: The initial very high-risk phase where only equity capital can be used for financing. Construction risk: The next high-risk phase where cost and time spillovers tend to distort the future revenue generation and profitability prospects of the project. The construction phase may be financed by a combination of equity and debt with guarantees. Operating risk: This risk emerges due to underestimation of operating costs and occasionally, an overestimation of the output from the proposed infrastructure facility. Since the pricing of infrastructure services is monitored closely by the government, the burden of underestimation of operating costs cannot be passed on entirely to the users. However, the operation phase is considered to be relatively low-risk and may be financed through bond issues. The operation phase may, in turn be divided into the introductory operation phase and project stabilization phase. During the introductory operating phase, the revenue stream is thin and operational bottlenecks hinder achievement of high-capacity utilization. It is only during the project stabilization stage that risks reduce considerably and revenues are more steady and predictable. Besides the above, there are other risks: Demand risk: This is a result of an overestimation of the demand and "willingness to pay" for the proposed infrastructure facility. In several cases, like the toll road network in Mexico, the demand for the facility is high but inadequate willingness to pay on the part of the users has raised serious questions about the future of such projects. Financial risk: Of specific relevance to infrastructure projects are foreign exchange and interest rate risks. Given that infrastructure projects involve costs and revenues in the local currency, the foreign exchange exposure taken for such investments, especially in the nature of off-shore debt, can prove to be risky. The interest rate risk emanates from the dependence on long-term debt for meeting capital costs. Market risk: This is important when consumers can choose alternative services such as with toll roads, railways and even ports. Occasionally, the Government absorbs this risk explicitly or by default. In a Mexico toll road, the Government awarded the concession guaranteeing a minimum amount of traffic. If this could not be achieved, then the concession period would be extended. It is difficult to hedge against market risk. However, when there is a single buyer for the output, the market risk is taken by the purchaser. Political risk: Inadequate clarity in Government policies and selection procedures has made political risk the fulcrum of infrastructure development. With an increase in the clarity in and conviction behind government policies, the extent of political risk is expected to decrease sharply. This risk profile would be the guiding map in designing financing packages for infrastructure investments. Despite these features, projects are rarely staggered or executed in an incremental manner. This is primarily due to the nature of the transaction and negotiation costs involved, which rarely vary with the size of the project. For example, the efforts made by a private sponsor for negotiating a 500 MW power plant would be comparable to the efforts required for a 1,500 MW projects. This adds to the lumpiness of the investments.