A Risk-Management Approach to a Successful Infrastructure Project
Large infrastructure projects suffer from significant undermanagement of risk throughout the life cycle of a project, as the management of risk isn’t properly accounted.
October 2015 | by Robert Harris
We estimate that a ten percent rise in infrastructure assets directly increases GDP by up to 1 percentage point.. Insufficient or underdeveloped infrastructure presents one of the biggest obstacles for economic growth and social development worldwide. In Brazil, for example, development is constrained by narrow roads, a lack of railways in the new agricultural frontiers, and bottlenecked ports, all of which are unable to meet the transport needs of a newly wealthy consumer mass.
Infrastructure projects are high on governments’ agendas, and the infrastructure-development and investment pipeline is huge. The current global project pipeline is estimated at $9 trillion, one-third of it in Asia. India is expected to spend some $550 billion on large-scale projects over the next five years, half of which will be in the energy and utility sectors. Developed economies also have significant infrastructure plans. The United Kingdom, for example, has identified an infrastructure pipeline of over 500 projects that is worth more than £250 billion.
However, major infrastructure projects have a history of problems. Cost overruns, delays, failed procurement, or unavailability of private financing are common. The final cost of the much-anticipated Eurotunnel between the United Kingdom and France, for example, was significantly higher than originally planned, while the Betuwe cargo railway linking the Netherlands and Germany came in at twice the original €2.3 billion budget and more than four times the original estimate. Nor are these problems confined to the past. Today, the construction of Kuala Lumpur’s new airport terminal, for example, is facing huge cost overruns and significant delays following frequent design changes.
In our view, most overruns are foreseeable and avoidable. Many of the problems we observe are due to a lack of professional, forward-looking risk management. Direct value losses due to undermanagement of risks for today’s pipeline of large-scale projects may exceed $1.5 trillion in the next five years, not to mention the loss in GDP growth, as well as reputational and societal effects.
Large infrastructure projects suffer from significant undermanagement of risk in practically all stages of the value chain and throughout the life cycle of a project. In particular, poor risk assessment and risk allocation, for example, through contracts with the builders and financiers, early on in the concept and design phase lead to higher materialized risks and private-financing shortages later on. Risk is also undermanaged in the later stages of infrastructure projects, destroying a significant share of their value. Crucially, project owners often fail to see that risks generated in one stage of the project can have a significant knock-on impact throughout its later stages.
The structuring and delivery of modern infrastructure projects is extremely complex. The long-term character of such projects requires a strategy that appropriately reflects the uncertainty and huge variety of risks they are exposed to over their life cycles. Infrastructure projects also involve a large number of different stakeholders entering the project life cycle at different stages with different roles, responsibilities, risk-management capabilities and risk-bearing capacities, and often conflicting interests. While the complexity of these projects requires division of roles and responsibilities among highly specialized players (such as contractors and operators), this leads to significant interface risks among the various stakeholders that materialize throughout the life cycle of the project, and these must be anticipated and managed from the outset.
And because infrastructure projects have become and will continue to become significantly larger and more complex, losses due to the cost of undermanaged risks will continue to increase. This will be exacerbated by an ongoing shortage of talent and experience—not only are projects more complex, but there are also more of them, which will create demand for more effective and more systematic approaches and solutions.
Surprisingly, the risks of large infrastructure projects often do not get properly allocated to the parties that are the best “risk owners”—those that have a superior capability to absorb these risks. This can result from a misunderstanding or disregard on the part of governments of the risk appetite, for instance, of private investors who are sensitive to the kinds of risks they accept and under what terms. Providers of finance will often be the immediate losers from poorly allocated or undermanaged risks. Even in public-private-partnership (PPP) structures, private-risk takers and their management techniques are introduced too late to the process to influence risk management and allocation, and therefore they cannot undo the mistakes already embedded in the projects. One crucial consequence is an increase in the cost of financing PPP projects and a greater need for sovereign guarantees or multilateral-agency support. In the end, however, society at large bears the costs of failures or overruns, not least in the form of missed or slowed growth.