TRIB 01 n20!4!36 Project Financing

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AITES

ITA

Towards animproved use

of undergroundSpace

In Consultative Status, Category II with theUnited Nations Economic and Social Council

http://www.ita-aites.org

ASSOCIATIONINTERNATIONALE DES TRAVAUX

EN SOUTERRAININTERNATIONALTUNNELLINGASSOCIATION

Risk assessment on Project Financing

PROJECT FINANCING

Title

Topic

published

Abstract: -

Rsum: -

Remarks: Contents:* The Roles of the Public and Private Sector, M. dal Lago

* Introduction to the Legal Aspects of Project Financing, J. Huse

* Dealing with geological Risk in Bot Contracts, E. Schneider

* Geotechnical Risks for Project Financing of Tunnels in Non-Urban Areas, G. Lombardi

* Economical Feasibility and Project Financing in Urban Areas, G. Goggi

* Trans-European Transport Neworks: a Political and Financial Challenge, E. Nowotny, Vice-President of the

EIB

* Financing the Lyon-Turin Link or the Gradual Revelation of a Firm Conviction, M. Rivoire

* Financing of the Eastern Distributor Motorway in Sydney, MIG.

in "Tribune",

Working Group: TF - "Task Force"

AuthorM. dal Lago, J. Huse, E. Schneider, G. Lombardi, G. Goggi, E. Nowotny, M. Rivoire, MIG

Open Session, Seminar, Workshop: Open Session 2001, Milano: "Project Financing"

Others: Meetings

by ITA - AITES, www.ita-aites.org

Nr. 20, pp. 4 - 36, Year 2001

Secretariat : ITA-AITES c/o EPFL - Bt. GC CH-1015 Lausanne - SwitzerlandFax : +41 21 693 41 53 - Tel. : +41 21 693 23 10 - e-mail : [email protected] - www.ita-aites.org


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During the World Tunnel Congress held in Milan lastJ une, the ITA Open Session had as topic Riskassessment for project financing. For the first time ITAdecided to publish in Tribune the papers presented atthis occasion. The five speakers treated the subjectfrom different point of views, but their conclusions areconverging.

M . S e rgio Dal Lago reminded that, considering thei n c reasingly small possibilities of public financing ofi n f r a s t ru c t u res, it is becoming more and more indis-pensable to call on private financing. He considersthat this is a good solution, but that it re q u i res clearand precise rules to define the basic and comple-m e n t a ry roles of the publicand private sectors.

J oe Huse, in his talk entitled I n t roduction to the LegalAspects of P ro j e c tFinancing, first gave a briefdefinition of project finan-cing. Then, he described thep a rticipants in a typical pro-

ject financing and the diff e-

rent phases of such a project.F i n a l l y, he reviewed brieflythe main project contractsand their contents. These contracts include theconcession agreement, the construction agre e m e n t ,the shareholders agreement, the operation and main-tenance agreement, supply and off-take agre e m e n t sand other agreements.

After having evoked the conditions of the use of theBOT contracts for infrastru c t ures, Mr Schneider pre-sented a model named KEFIR , imagined and deve-loped by Mr.Spiegl at the faculty of Innsbruck. T h i s

model, which applies to underg round works re a l i z e dwithin the framework of turnkey contracts, is aiming toincrease the use of BOT contracts in the field of hydroe-lectric facilities. By allowing a better distribution of risks,it favors innovative propositions and stimulates competi-tion among the tenderers.

Mr. Giovanni Lombardi reminded that physical as wellas economical circumstances limit the amount ofinvestigations and analysis preceding the constructionof an underground work. The knowledge of the groundwhich will be actually met during the construction is sovery often limited. The longer the tunnel, the greater its

depth, the larger its section and the more complex itse n v i ronment ; the more vague and fuzzy is the avai-lable data.The establishment of relevant contractualclauses on such fuzzy data sometimes leads to drama-tic situations.

To illustrate the problems of project financing in urbanareas, M.Goggi refered to the example of the project ofthe underground ring road Bastioni in Milan, with alength of about 12km. He underlined its importance asregards traffic, town planning and environment for thecity of Milan. After presenting the main functional andtechnical characteristics of this project, he underlinedthat, considering the very strong demand for mobility, the

financial profitability of thisoperation was ensured, whichmade it possible to call onproject financing.

Following the pre s e n t a-tions, a long and livelydiscussion took place withMr. Colin Kirkland (UK), J ohnReilly (USA) and AdolfoBalesteri (Italy) and the spea-

kers.

In this issue ITA is publishingt h ree other papers re l a t e dto the subject.

The first one is presented by the Vice-President of theEuropean Investment Bank, on the political and finan-cial challenge of financing Trans European networks.

The second one is related to the project for a new raillink between Lyon in France and Turin in Italy andattempts to explain the view of the regional promoterswho had to demonstrate to the governments the eco-nomical feasibility of such a project with the implica-

tion of private and public financing.

The third one is related to the financing of a motorwayin Sydney and explains the banks point of view andhow a project of an amount of nearly 500 US$ can befinanced.

You may be surprised by the cover chosen to illustratethis issue. It is an illustration of the boring of the rail-way tunnel Tunnel du Mont-Cenis between France andItaly in the 1860s. This tunnel is one of the first public-pri-vate partnerships for the construction of a tunnel, bet-ween the Sarde railway private company and theKingdom of Piemont

I N T R O D U C T I O N

TRIBUNE n20 - ITA-AITES - December 2001 4

R I S K A S S E S S M E N T O N

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AITES

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The Roles of the Public and Private Sector

PROJECT FINANCING

Title

Topic

published

Abstract:

Rsum: Compte tenu des possibilits dcroissantes de financement public des infrastructures, il devient de plus en plusindispensable de faire appel au financement priv. Cette solution est bonne, mais elle ncessite des rgles

claires et prcises pour dfinir les rles essentiels et complmentaires des secteurs publics et privs.

Remarks:

in "Tribune",


AuthorM. dal Lago


Others: Meetings


Nr. 20, pp. 5 - 9, Year 2001



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The world is witnessing to an ever-increasing need forinfrastructures, the constant adjustment of the exis-ting ones and an increasing these infrastructures tocomplement one another.

This is an essential requisite for development, but itrequires ever-increasing financial resources which the

public administrations do not have at their disposalsince they largely exceed any fiscal revenue, or anyphysiological indebtedness capacity.

As a matter of fact, the experience of the last few yearsshowed that within the sector of large infrastructures it isnot possible to rely upon considerable public financing,and it has become increasingly obvious that the situationis unlikely to significantly change in the future, given theEuropean restrictions imposed at theTreaty of Maastrichton national budgets.

Nowadays the relaunching of investments in the publicservices sector can and must take place by turning tothe capital market whenever possible.

The only solution for anybody who wants to intervenein the sector can is aim at works capable of auto-financing or, otherwise, at works considered as apublic utility, towards which the public administrationsare willing, for the direct and/or direct benefits recei-ved, to pay the fee of a shadow-traffic, or to ack-nowledge a rate.

Hence, the need to involve external financialresources which are made available once a project isduly renumerated and guaranteed even if there is ameasured and well considered valuation and risk sha-ring.

Both the South American system, which witnessed inthe last decade an extraordinary wave of privatisationin the field of gas supply, production and transport ofhydro-electrical and thermoelectrical power, and theEnglish system (PFI & PFP) for the completion of hos-pital infrastructures, prisons, airports, motorways, hadconsiderable recourse to private capital.

The English choice is based on the opinion that in apost assistance state the citizens, in return for theshare of taxes they pay, are more interested in thesupply of public services rather than the accumulationof fixed capitals.

In other words they are interested in the availability of

beds in hospitals, safety of the prisons, practicabilityof the roads, quality and respect of the environment.

Consequently, the Public Administration changes itsrole, becoming a collector of petitions, ratifies the prio-rities and concentrates its efforts in the identification ofthe services required to meet demands and chal-

lenges the private entrepreneurial class to rispost byproposing the supply of services with the best quality-times-price ratio.

Ultimately, the public sector is transformed fromowner of assets into purchaser of services, thus fullyfitting into the market, so that the traditional catego-ries of investments become outdated, sometimesobsolete and the distinction with the private sectorfades away.

By now, the system is running yet has to comply withthe fundamental requirements, the first of which isessential, that is the need for a project.

A project meets the requirements to be financed ifnecessary, when it is possible to value the cost-bene-fit ratio generated by the project and, accordingly, toacknowledge a price to be paid (fee), or, for the PublicAdministration, to aknowledge the benefits from cer-tain advantages (decongestion, decrease of accidentsand pollution, etc.), regarding its utilisation and theprofitability by the users.

The economic-financial feasibility of the project. Thefeasibility study must take into account all the factorsintervening both during the construction period andduring its management. It is necessary to start from thelaws and regulations governing the sector the project

refers to, motorways railways, airports or inter-ports,and the market, or in the case of the transports, a traf-fic study, its development, the fees, the possible sea-sonality or factors affecting the regularity thereof.

The real project, i.e. the technical and technologicchoices to carry out the work, so that the projectmakes as much headway as possible, at costs as cer-tain as possible, consistent with the quality imposedby regulations and specifications, and with an effecton the environment as limited or as mitigated as pos-sible. The investment cost is thus obtained.

The investment value and a preliminary valuationconcerning the distribution of the amount among own


1 THE ROLES OF THE PUBLIC AND PRIVATE

SECTORCompte tenu des possibilits dcroissantes de financementpublic des infrastructures, il devient de plusen plus indispensable de faire appel au finan-cement priv. Cette solution est bonne, maiselle ncessite des rgles claires et prcisespour dfinir les rles essentiels et compl-mentaires des secteurs publics et privs.

M. Dal Lago


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means placed by the promoters as risk capital and theamount one intends to apply to the financial market,generate the first approach to the financial leverage,that is the leverage between capital and debt. In road-type infrastructures experience shows that such aratio can rarely be under 20% of own means and 80%of financing. Such ratio generally corresponds to 25%- 75%.

The legal, contractual and financial structuring of theproject that must guarantee that the risk be fairly sha-red out throughout the duration of the concession.Risk sharing is one of the fundamental factors of the

possible success of a project.The Italian answer to this infrastructure financingmethod is represented by the so-called Merloni ter(Law no. 415 of 18.11.88) that implemented art. 37bisnonies to the outline law 11.2.94 no. 109 concerningPublic Works.

By this intervention, which is still subject to heateddiscussions at European level, the legislator hasnev e rtheless made great progress in meeting theeconomic operators expectations, guaranteeing.

Higher certainty and steadiness of the law and therelation between the administration and the private

bodies interested in financing a work or a service,allow the introducion of two instruments which makespossible the use of the Project Financing technique.

The first instrument is that of the Promoting Body,which is a private body, aspiring concessionairewhich makes provisions to preliminarily identify andplan the public works to be carried out and to mana-ge in Project Financing, and to submit to the Admi-nistration a proposal accompanied by a certifiedfinancial plan and adequate guarantees. If the Admi-nistration considers it to be of public interest, it willthen place a tender base.

The second instrument is represented by the bankabi-

lity of the concessions of construction and manage-ment (both those at administrations initiative and thoseproposed by the promoting body). The bankabilitybecomes apparent via the possibility to establish theproject company (special purpose vehicle, SPV), and toprovide guarantees to the potential financiers, amongwhich the possibility of replacement with a newconcessionaire (chosen by the financiers) in the eventof non-performance of the original one.

The introduction of such provisions, even thoughmany normative points remained to be resolved andw e re only partially addressed by regulations publi-shed rec e n t ly, allowed Italy to approach to the tes-

ted PFI Britannic system, while keeping elements ofrigidity and formalism typical of the Italian adminis-trative law.

Special attention has to be paid to the contractualf o rms through which the concession re l a t i o nbecomes manifest. From the historical DBFO (Design,Build, Finance, Operate). To the most modern andpopular BOT (Build, Operate, Transfer). BOOT (Build,Own, Operate & Transfer). LOT (Lease, Operate &

Transfer). ROT (Rehabilitate, Operate & Transfer).

It is plain that in any contractual model, the legal andfinancial structures and risk sharing - with consequent

different financing cost and finally different servicessupplied must change.

It is also plain that the private sector, warned, panderedto and cited by this New Deal, that is the constructionof works and the repayment through the supply of ser-vices, is driven by a mainspring represented by the pro-fit.

The construction of the public works awarded withmaximum mark-down prices, has reduced theContractors margins to the verge of starvation,often with a boomerang effect for the Administrationsthat saw the business concerns fail, and had to com-

plete the works with considerably extended deadlinesand at inflated prices.

Project Financing, if well carried out, should be anindex of maximum financing and contractual transpa-rency and fair profit for everyone.

All the private bodies concerned are important andare bound to the rules that, once they got ready,become strict (the centrality of the contract in the pro-

ject financing).

The private Players of this game are essentially thefollowing :

the Sponsors (or Promoters according to Merloniter) are therefore the promoting bodies or the part-ners of the project company (SPV) which becomescounterpart of the concession contract (that is theconcessionaire). It is plain that the reputation, thereliability, the financial capacity and the experience ofthe sponsors lends credibility to the SPV.

Financial Advisor is essentially the advisor who,through the collection and the processing of all thedata concerning investment, management, feasibilitystudy, engagements, revenue hypothesises, trafficflows, verifies and prearranges the so-called BankPackage, or the investment / financing proposal.


1 THE ROLES OF THE PUBLIC AND PRIVATE SECTOR


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The Contractor is the General Contractor who is incharge of the carrying out of the work on GMP on T/Kbasis with general liability to : price, times, quality.He shall be in a position to guarantee with a proper P.B.his skills as contractor. It is plain that reputation, financialskills, technical skills and experience are essential.

NOTE : here the price will not be too low because itmust allow the certainty of the completion of thework. Therefore, as to the contractors, reference isstill to be made to fair margins.

The operator is the body who guarantees, throughthe use of the work and its correct maintenance, the

supply of service and toll collections, rates or consi-derations to repay the cost of the work. Also in thiscase the operators reputation and experience areessential for project reliability.

It has to be noted that it is advisable for both theContractor and the Operator to join the Project Com-pany with non-majority shareholdings, but with a sha-reholding of some account.

The composition of the partners of the project com-pany and the contribution of capital with respect tothe global amount of the investment are two essentialelements for the project's success.

Also the Public Administration granting the conces-sion can join the project company (in England the PFP,in Italy the Private / Public Company pursuant to Law142), and this can considerably strengthen theFinancial Appeal of the operation.

The financing leverage for the financing of the projectultimately consists in a series of factors among whichthe ratio between the SPV capital and the requestedfinancing is the most important.

But such a ratio, as well as the cost of money, andconsequently the fees, can be optimised through thedifferent sharing of certain risks and/or the introduc-

tion of the covenants, that is the guarantees andcollateral obligations suited to strengthen thecontractual structure or to mitigate the global risk ofthe project.

In order to better outline a Project Financing structu-re, I am hereby explaining you slide A. It is plain thatthe concession contract represents the mainspring ofthe whole project. It is likewise plain that the contractis generally divided into two essential phases :construction and management.

In this kind of operation and for complex infrastruc-tures, for example a motorway with more exits andentries, the project can be carried out in more subse-

quent phases, but every single phase must have itsown income balance. While in the case of a toll over-pass or tunnel, it is necessary that at the beginning ofthe works all the funds required to cover the invest-ment are paid-up or guaranteed.

During the construction phase the main risk is assu-red by the General Contractor who is bound throughthe issuance of the Performance Bond and adequateinsurance coverage to complete the work accordingto the costs and the schedule provided for and withthe adequate quality. During the exercise, the risks areborne by the Operator and the Market.

In the case of a road or an overpass such risks can,for example, imply that the Operator is not able toguarantee short waiting times at the tollhouses duringthe rush hours, or to carry out a proper maintenanceof the road surface etc., thus inducing the users tochoose alternative routes.

On the contrary, the market is represented by thetr a ffic risk that is the main risk for infrastructuresc on c e rning transport.

The traffic, that is the usership, pays a toll to use theinfrastructure operated and managed by the operator.

The toll constitutes the main proceeds of the conces-

sion and, consequently, the guarantee that such pro-ceeds are sufficient to remunerate and repay theinvested capitals and the maintenance and manage-ment expenses, is essential. We will now examinehow the tolls can be Real (Pay tolls) or Virtual (Shadowtolls) or a mix of both.

In the light of the foregoing and based on experiencewe can state that there is an important tendency ofinvestors to invest in toll roads, considering differenttypes of investors: banks, funds, investors in obliga-tions, debt suppliers, investors in subordinated ormezzanine debts.

The main attractions are :

The considerable initial capital amount offers a signi-ficant well-paid and long-term investment opportunity.

The assets are tangible and long-lasting.

The high social value is interesting for the govern-ments and galvanises the Governments support.

On the other hand, the fundamental risks that worrythe investors in toll roads are :

the risk connected to the project development, per-mits suited to guarantee the carrying out of the route,




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schedules and amounts of the expropriations, etc...,

the risk connected to the construction, above all theone related to critical structures such as overpasses,tunnels etc...,

the well-known traffic risk,

the operative risk : survey stru c t u res, terms ofpayment, etc..., the risk connected to the life cycle : extraordinaryrepairs and costs thereof.

Therefore a combination between contractual structu-re, financial plan and insurance programmes is able to

manage most of the risks. But the traffic-related risk isby far the most delicate.

One of the methods to mitigate or annul such a risk isrepresented by the virtual toll, that is a preliminaryvaluation of the traffic and the cost-benefit ratio of theancillary situations for the benefit of the community, sothat the Public Administration acknowledges to theconcessionaire a toll for a prearranged hypothesis oftraffic, in substance almost a minimum guaranteed rate.

For example a road with a high rate of accidents, vio-lent effects on the environment due to traffic conges-tion, overcrowding and pollution has been replacedby an expressway granted in concession wherein theusers do not pay the toll, but the Municipality pays arate deriving from minor social costs (health, environ-ment, etc.) which attracts the investors since it trans-fers the traffic risk (i.e. the Market) to the redemptioncapacities of the Public Administration concerned.

Nevertheless there are some contra-indications :

If there is no obligation to pay, all the drivers tend tochoose the new best route, thus creating a swift over-crowding and reducing the advantages.

The taxpayer feels as if he is a financier of the drivers :loss of consent at political level.

Is the budget able to manage a virtual toll situation?A government determined to support the virtual toll andto inform the taxpayers and the users is necessary.

The optimum choice, in the case of uncertainty thatthe traffic risk is not identifiable, is represented by amix of minimum guaranteed and controlled toll suchas (for example) the one adopted in the ConcesionesGran Via of Santiago of Chile.

The concession data are :An expectation range of traffic with a minimum guaran-teed for 20 years suited to cover the capital and interestredemption equal to 75% of the total value of the invest-ment (construction, investment costs, issuance, etc.).

Duration of the concession : 25 years.

Period of grace: 5 years.

Coverage ratio of the debt : 1.1.

Leverage 75% debt 25% capital.

Interest rate: 8.5% net in U.S. $.

If the annual profits are less than the minimum gua-ranteed, the Government pays the diff e re n c e .

If the traffic lies within the expectation range, theconcession operates regularly.

If the traffic exceeds the expectation range ceiling, theprofits deriving from the traffic in excess are 50% due

to the concessionaire and 50% to the Government.

This mechanism added to a Collar Swap, that is anexchange risk mitigation between the local currencyand the foreign currency of the debt, allowed thefinancing of the work at an U.S. $ rate that is consi-derably competitive for a South American country.

The leverage 75% debt 25% own means was adop-ted also by Bre.Be.Mi SpA, the Promoter of RaccordoAutostradale Diretto [Direct Motorway J unction] Mila-no-Brescia, which provides for a global investmentequal to approximately 1,300 billions.

RATINGSince the infrastructures investments are conside-rable, often more and more investors, banks, funds,etc. must intervene in a single project and take only ashare of the debt, whether it is main or subordinated(or mezzanine). Not always the single investors havetime, will or resources to carry out a complete.

Due Diligence of a project considering all the riskaspects, restitution and reliability capacity; from theforegoing derives the importance to grant a Rating tothe project. All of us heard about AAA, AA, BBB, etc.

Well, this is an index issued by a specialised agency

(e.g. Moodys, Standard and Poors, among the mostfamous), which gives a suggestion about the reliabili-ty and the project risk.

It is a kind of mark issued by an independent bodythat has carried out a Due Diligence and establisheda credit merit.

The more the mark is high, the more the project finan-cing is easy and profitable, and if the mark is higherthan the Investment Grade (i.e. a permitted floor) thedebt title can be placed on the public market andsplit, with the certainty that the investors will buy it.

It is easier to place the debt in small tranches with goodprofitability rather than negotiating with a single investor.




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The Rating is a factor of split facility and placing ofthe debt, and the Rating takes into account both thereliability of the Public Administration and the reliabilityof private bodies concerned.

CONCLUSIONS

Ultimately the conclusions to be drawn as to theroles, between the public and the private sector toaid and optimise the infrastru c tu re investments canbe summarised as follows :

> The public sector shall :

Become the interpreter of the needs and stimulatethe investments.

Lay down clear rules, guarantee of the law, certaintyof bureaucratic and legal times, take steps to adjustlaws and regulations (Merloni ter and establishmentof the Technical Unit, Project Financing are twoexamples), but also act on the taxation sector.

Carry out a support action for the initiatives of public

utility also assuming a part of those risks that cannot

objectively weigh only on the private body (traffic risk,

minimum guaranteed or income support guarantee).

> The private sector shall :

Satisfy the public sector objectives.

Stimulate the identification and planning of said

objectives and be proponent as to projects that are

actually necessary and with income capacity.

Be available to long-term investments.

Accept the transparency and the implicit controls in.


Massimo Sergio Dal Lago, ArgentinaTORNO INTERNAZIONALE S.p.A., Milano


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AITES

ITA


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Introduction to the Legal Aspects of Projet Financing

PROJECT FINANCING

Title

Topic

published

Abstract:

Rsum: Qu'est-ce que le financement de projet?Qui sont les participants, les diffrentes phases?

Quelles sont les diverses natures de contrats?

Remarks:

in "Tribune",


AuthorJ. Huse


Others: Meetings


Nr. 20, pp. 10 - 13, Year 2001



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INTRODUCTION

What is project financing ?

Project financing is financing the development orexploitation of a right, natural resource or other assetwhere the bulk of the financing is not to be provided byany form of share capital and is to be repaid principal-

ly out of revenues produced by the project in question.

The essence of project lending is therefore its focuson the project being financed. The project lenderlooks, wholly or mainly, to the project as the source ofrepayment; its cash flows, and assets where appro-priate, are dedicated to service the project loan. Theproject cannot even begin to provide for repaymentuntil it is operational, and then depends on continuedsound operation, so its analysis is critical.

Key elements of project financing

The financing of the project is made available andthe money is invested before the construction of the

infrastructure is completed.The project lenders have no recourse outside thespecific project (or only limited recourse). This meansthat the project lenders limit their recourse to the pro-

ject companys assets and revenues in case the projectcompany is unable to repay its debts. Therefore, thereare no guarantees of the project companys obligationsto repay loans other than the security provided by itself.

Project financing is usually used for :- natural resource projects (mines, hydrocarbons, etc),- infrastructure improvements (including power stations)- new industrial plants (factories).

Major risks involved in Project Financing Completion (construction) risk : who is responsiblefor ensuring completion is achieved.

Revenue risk : how reliable are revenue forecasts ofthe project.

Political risk : host government interference.

WHO ARE THE PERSONS INVOLVEDIN PROJ ECT FINANCING

The host government

The objectives of the host government in putting aproject up to tender (i.e. selecting sponsors to deve-

lop a project usually by way of a tender process andallowing a private sector entity to develop a projectare usually the following :

to satisfy the national interest by developing a project,

to bring the project back into public ownership oncethe private sector has received an acceptable return

on its investment (BOT),

to have adequate safeguards and assurances that theproject will be operated properly and in the public interest,

to reduce or eliminate the need to use the govern-ments own funds or borrowings,

to limit the undertakings given by the State,

to be able to offer the ownership and/or operation ofthe project to other private sector entities should theoriginal private sector participants fail to provide therequired level of service or run into financial difficulties.

The private sector sponsors

The private sector sponsors are the companies whooffer to develop a project. Their objectives are usuallythe following :

To satisfy a strategic corporate objective bycompleting the pro j e c t .

To extract profit by :- simple investment return,- selling equipment or raw materials to the projectcompany,- by buying the projects products.

To share the risk in carrying out a project (the damageof the project if it goes wrong is shared with the otheractors (i.e. banks, suppliers, contractors, off-takers andhost governments).

To carry out the project off balance sheet (horsbilan) the sponsor developing the project does nothave to show any borrowing for the project among itsborrowings in its consolidated accounts.

The project company

A special purpose vehicle is usually incorporated by theproject sponsors specifically for the needs of a project.

The project company will have the following features : its scope of business will usually be restricted (both byconstitution and by finance documentation) to the project, capital structure of the project company generally


2 INTRODUCTION TO THE LEGAL ASPECTS

OF PROJ ET FINANCING

Qu'est-ce que le financement de projet?Qui sont les participants, les diffrentes phases?Quelles sont les diverses natures de contrats?

J . Huse


11/42

involves a relatively aggressive debt to equity ratio, limited liability company structure in order to insulatethe sponsors from the risks and liabilities inherent tothe project, flexibility of management structure, ease of dissolution.

The contractor (s)

The project company will generally enter into one ormore construction agreements in order to provide forthe construction of the main project assets (i.e. powerstation, toll road, factory).

Operator

The project company will generally enter into an ope-ration and management agreement (O&M agreement)with an operator, which shall operate and manage theproject at certain levels of quality and quantity.

Supplier

The project company will need supplies in order toproduce/manufacture goods or services and thesesupplies shall be provided by one or more suppliers.

Off-Taker

The project companys revenue will exclusively (inmost instances) be generated by the sale of its pro-

ducts or services to one or more buyers generallyreferred to as off-takers.

Political Risk Insurers

The development of a project often involves foreignsponsors being involved in a State represented by ahost government where there is a potential risk thatthe host government does not respect its underta-kings vis--vis the sponsors and/or the project com-pany, expropriates the project company from itsassets or renders the project revenue difficult orimpossible to convert into hard currency.

In order to cover such risks, banks, sponsors and theproject company usually take out political risk policies

with political risk insurers. Political risk insurance isgenerally provided by national agencies, whichencourage national exports, commonly referred to asexport credit agencies or ECAs :

In France : COFACE (Compagnie Financire dAssu-rance pour le Commerce Extrieur).

In Germany :HERMES (Hermes Kredit-Versicherungs AG)

In the United Kingdom : ECGD (Exports Credits Gua-rantee Department) etc...

Others

In some instances the project company will also needto enter into an agreement with a technical assistant

to provide technical assistance for the managementof the project.

In all cases the project company shall take out insu-rance policies covering damages to third parties or toits assets and loss of profit by entering into agree-ments with insurers.

PROJ ECT PHASES

Construction Phase

Prior to and during this phase :

The project contracts and the finance documents

are negotiated and signed.The contractor(s) commence the construction of theproject assets.

Money is invested in the form of :- equity (by sponsors),- subordinated loans (from sponsors),- government grants (by host government),- senior project loan (by project lenders).

This phase finishes when the project assets are com-pleted and are ready to be operated commercially.

Operating Phase

During this phase :

the assets are operated and maintained and revenuesare generated, government subsidies are eventually perceived, the project loans are repaid by the project company.

MAIN PROJ ECT CONTRACTS

Concession Agreement

The agreement entered into between the sponsors /project company and the host government by virtueof which the project company is authorised to deve-lop the project.

The main clauses of this agreement involve : scope of responsibility of the project company andhost government, statutory requirements and hostgovernment authorisations, the description and speci-fications of the site granted to the project company forthe purposes of the development of the project, thetechnical specifications of the project, payments to bemade by the project company to the host government(concession fee), payments to be made to the projectcompany if the host government is the off-taker, gua-rantee by the host government of foreign exchange avai-lability and transfer of funds, tax regime of the projectcompany and the project, performance guarantee, reporting and regulation, Force Majeure, guarantee


2 INTRODUCTION TO THE LEGAL ASPECTS OF

PROJ ECT FINANCING


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against change in circumstances, duration, gover-ning law, dispute resolution.

Construction Agreement

A construction agreement is the agreement wherebyone person (the contractor) agrees to construct a buil-ding or a facility for another person (the employer) foran agreed remuneration by an agreed time.

In a complex construction project comprised ofvarious interlocking parts (involving both civil andmechanical and electrical works), the basic decisionto be taken is whether to have a contractor respon-sible for all of the works (a turnkey contract, contratde construction cl en main) or to have the individualcontractors enter into separate contracts with theemployer but to have them subject to control by oneoverall project manager.

Often a turnkey contract is preferred in order to insu-re that the turnkey contractor assumes overall risk forcompletion as well as the risk of performance of thesub-contractors.

The main clauses of this agreement involve : technical specifications, authorisations to beobtained for the works, completion agenda, tes-ting procedures and performance parameters,

determination of phase / final completion, fixedprice and provision relating to overruns and pay-ments, liquidated damages payable for delay inachieving completion, transfer of property and risk, construction bond/completion guarantees (garantiedachvement), insurance arrangements, coope-ration and coordination during the works, final provi-sions (governing law, dispute resolution etc.).

Shareholders Agreement / J oint-Venture Agreement

The shareholders of the project company are in mostinstances the sponsors of the project. Due to the par-ticularities of some jurisdictions and more generally

those involved in the management and financing of aproject company, the shareholders often enter into ashareholders agreement.

The main clauses of this agreement involve : voting rights, nomination of management / majordecisions, dividend distribution, p re - e m p ti onrights, each shareholder's contribution in equity tothe project company and its agenda, non-dilution, shareholders loans, conflict of interests (if one ofthe shareholders is a party to an agreement to beentered into with the project company), non-com-petition clauses, final provisions.

Operating and Maintenance AgreementIn most instances the project company will enter into anagreement with an operator which will be responsible forthe operation and maintenance of the project facility.

The main clauses of this agreement involve : scope of responsibility of the operator, operator'sfees, guarantee that the project will achieve certainoperating levels (production and efficiency), opera-tion bonus/liquidated damages, cooperation andcoordination, operation and maintenance fees, final provisions.

Supply Agreements

In most instances the project company will need toenter into a number of supply agreements in order topurchase the main supplies for the operation of theproject facility. These may include feed stock (rawmaterials for the manufacturing process), fuel (forelectricity generation or for the supply of power to theplant) or renewable equipment.

The main clauses of this agreement involve : level of supply, price (fixed or indexed), supplyguarantee, quality of supply, liquidated damages, final provisions.

Off-Take Agreements

A project need not necessarily have an off-take agree-ment in the sense of a long term product purchaseagreement since :- its products may only be capable of being sold onworld spot markets (e.g. crude oil),- its revenues may simply be payments from thegeneral public (of tolls or fares).

An off-take agreement is a long-term sale agreementof the project products with one or more off-takerswith the following characteristics : long-term sales, fixed or agreed price, purchaseguarantee (take-or-pay).

Other

The project company will in all instances enter intoassurance arrangements. The project company mayalso enter into a technical assistance agreement.

FINANCE DOCUMENTS

Loan Agreement

This agreement is entered into between the projectcompany and a bank or a syndicate of banks repre-sented by an agent acting in their name and on theirbehalf if the loan is syndicated.

This agreement will provide for the partial financing of theproject (since the project will also be financed by equity,



PROJ ECT FINANCING


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subordinated loans, host government subsidiaries, etc.)

The loan agreement will contain the following provisions :

> Basic Provisions : general conditions precedent, conditions precedent to each drawdown, draw-down mechanics, interest clause (Euribor, Libor, etc..plus margin), repayment clause, margin protectionclauses (gross-up clause, increased costs and marketdisruption), illegality clause, representations andwarranties, undertakings, events of default.

> Specific Provisions : non-recourse or limitedrecourse clauses, cover Ratios and Net PresentValue, control accounts (disbursement account,proceeds account, compensation account (for insu-rance payments), debt service reserve account and amaintenance reserve account), hedging (protectionof a borrower from adverse movements in currencyexchange rates, interest rates and commodity prices)

Security Package

Lenders take security over an asset or a right in orderto sell it if their loan is in default and to apply the pro-ceeds against amounts outstanding under the loan.

In project finance the lenders' main legal concern isalso to ensure : that they can take effective security over the main

project contracts, that the key contracts remain in place in one from oranother if and when they enforce their security.

In order to achieve the first concern, each contractmust be charged or assigned to the lenders by way ofsecurity and any consents required from the othercontracting parties for this to occur must be obtained.

In order to achieve the second concern, it will benecessary to examine the termination clauses in eachcontract. Often, there will be provisions entitling theother contracting parties to terminate the contract ifthe project company is insolvent or if any security it

gives is enforced. For this reason, lenders will usuallyseek to have the provisions amended or to have theother parties enter into direct agreements with them.

Direct agreements are agreements entered into bet-ween the project company, the banks financing a pro-

ject and the parties to the projects key commercialcontracts.

The key contracts for these purposes would typicallyinclude the concession agreement (if any) theconstruction agreement, any long-term supply agree-ment and any long-term sales agreement.

Direct agreements are also sometimes sought from theauthorities issuing consents necessary for the project.

The objective of a direct agreement is basically toenable the banks to step into the shoes of the pro-

ject company if it defaults in its loans obligations.

Banks would usually expect a direct agreement relatingto a commercial contract to contain the following :

consent from the third party to the project companycharging or assigning by way of security the projectcompanys rights under the relevant contract (to suchextent such consent was required),

an undertaking from the third party that it would notexercise any right it had to terminate the contractwithout first giving the banks a specific number ofdays prior written notice,

an agreement from the third party that, if it gave thebanks notice of the type referred to above and thelenders in turn gave it a counter notice, then the thirdparty would either allow the banks (or an agentappointed by them) to assume the project companysrights and obligations under the contract for a speci-fied period of time or allow the transfer of the contractto a separate company (a work-out vehicle) establi-shed by the banks for this purpose.

Intercreditor Agreement

The intercreditor issues that arise in project financing

are related to situations where there is more than oneprovider of debt finance. If one layer of finance is to besubordinated to another, an intercreditor agreementwill usually set out the terms of the subordination.

If no layer of finance is to be subordinated to another,an intercreditor agreement will usually address issuessuch as whether all of the categories of lenders haveto agree before any of them can accelerate their loansor take enforcement action and whether or not anycategory of lenders is to have the right to veto anyproposed exercise of a discretion under any other len-ders credit documentation.

Intercreditor agreements will typically contain the fol-lowing provisions : voting arrangements and proce-dural provisions relevant to decision making, appointment of agents and similar entities to per-form specific functions on behalf of groups of lenders, disclaimer provisions for the benefit of agents, application of cash as amongst different groups oflenders (not all of them may have the benefit of thesame security), order of application of cash as tospecific project and lender requirements (waterfallcascade).

TRIBUNE n20- ITA-AITES - December 2001 13


PROJ ECT FINANCING

J oseph Huse, lawyer,Freshfields Bruckhaus Deringer


14/42

AITES

ITA


of undergroundSpace





Dealing with Geological Risk in Bot Contracts

PROJECT FINANCING

Title

Topic

published

Abstract:

Rsum: Le modle "KEFIR" imagin et dvelopp la facutl d'Innsbruck s'applique aux ouvrages souterrains ralissdans le cadre de contrats cl en main. Il a pour but d'accrotre l'utilisation des contrats BOT dans le domaine

des installations hydrolectriques.

Remarks:

in "Tribune",


AuthorE. Schneider


Others: Meetings


Nr. 20, pp. 14 - 18, Year 2001



15/42

BOT-MODELS FOR INFRASTRUCTURE

BOT models are being used worldwide in the infra-structure sector. Many successful examples for tollmotorways, toll bridges, thermal power plants, watersupply plants etc. prove that this model is attractivefor the private sector. However, only a small number

of projects have been realised in the field of hydropower plants, and those are only projects without anysignificant sub-surface works (such as the Birecikpower plant at the Euphrates river in Turkey).

Examples of Infrastructure where BOT-Modells can be adoped.

BOT models for major sub-surface works

Projects with a substantial sub-surface works, in par-ticular long diversion and pressure tunnels, shafts,and caverns (which are typical of high and mediumpressure hydro power plants), as well as long roadand rail tunnels include a high geological risk. Usingthe contracts and risk allocation schedules that havebeen usual with BOT models so far, such projects aremostly unattractive for private investors (as has beenshown in India), because different types of infrastruc-ture have different risk profiles.

To stimulate the application of the BOT approach tosuch projects, it is necessary to develop an approachthat takes the special risk potential of such projectinto consideration. Furthermore, the current practicein most cases of negotiating with only one interestedparty is not only unsatisfactory for the owner but alsodetrimental to the national economy, and should be

modified in the direction of more competition.

In his doctoral thesis, M. Spiegl [7] has developed amodel that offers a convincing solution for both pro-blem areas. Another objective to be realised with thismodel is the promotion of qualified competition thatrewards primarily the bidders' innovation potential and

know-how rather than their readiness to take risks.System provider concept

The system provider concept offers substantialadvantages for BOT models in the construction ofhydro power plants and traffic tunnels. In that case,the bidder has the incentive to optimise the projectover its whole lifespan in a holistic way. Under opti-mum circumstances, the concentration of the wholeperformance range of design, financing, construction,operation and maintenance in one hand means thatthe criteria for low lifecycle costs are already takeninto account during design [2].

In most cases, the organisation form of the consor-tium has been selected for the construction of largehydro power plants. Due to the major part taken byconstruction work in the total package, such consor-tia have been mostly led by a construction company.

Risk sharing

In contrast to current practice, it is not sensible to letthe bidder assume a project's unlimited risk from geo-logy and hydrology because the resulting risk sur-charge would make the project unviable. It is moresensible to have risk compensation - at least forextraordinary risks - compensated via the owner's

project portfolio, and have the licensee assume geo-logical risks, (and in the case of hydro power plants,also hydrological risks) only to a limited extent.

In general, the contractor is also unable to assumeunlimited risks due to financing constraints, as doingso might exceed the scope of financing. The assump-tion of extraordinary risks by the owner - expediently,by forming a risk fund - also ensures that competitionis not exclusively about readiness to take risks. Lowerproject risks make the project more attractive forcompetitors and lead to more extensive competition.

Standard contracts for BOT models

On an international level, the FIDIC EPC Turnkey


3 DEALING WITH GEOLOGICAL RISK IN BOT

CONTRACTS

Le modle "KEFIR" imagin et dvelopp lafacult d'Innsbruck s'applique aux ouvragessouterrains raliss dans le cadre de contrats

cl en main. Il a pour but d'accrotre l'utilisa-tion des contrats BOT dans le domaine desinstallations hydrolectriques.

E. Schneider


16/42

Standard Contract (Silver Book) has established itselffor BOT projects. That contract implements projectson a fixed-price turnkey basis and with a strict two-party approach, which involves a higher degree of riskfor the contractor. In this, it deviates from the FIDICprinciples of a balanced risk sharing (Red Book). It istherefore not suitable for projects with a large amountof sub-surface work. This is expressly laid down in theSilver Book.

The following K E F I R model has been developedin order to also enable the application of this provenstandard contract to projects with a large sub-surface

component. It provides a formula for fair risk-sharingbetween contractor and owner and a correspondingremuneration clause.

The most important novelty is the introduction of anupper limit of risk expressed in monetary terms up towhich the contractor takes on the full geological risk.

The cost and time consequences of risks exceedingthat limit is assumed by the owner. This gives contrac-tors as well as financing institutions a better overviewof the risks and a better basis for calculation.

Modular integration of the "K E F I R" module into e.g. the FIDIC

EPC Turnkey Contract for projects with sub-surface works.

THE "K E F I R" MODEL

In the following, this paper concentrates on the sub-surface works handled by the "K E F I R" model in theframework of e.g. an EPC Turnkey Contract.

The acronym K E F I R stands for Kosten-Einbrin-gung von Know-howFinanzierungInnovationRisi-ko, which means CostInput of know-howFinan-cingInnovationRisk.

In this paper we are using the term contractor ins-tead of project company or concessionaire andowner instead of host government which are also

often used in context with BOT.

Necessary basic conditions and requirements

The model described below assumes that there havebeen preceding pre-qualification proceedings (as isusually the casel). The concept also assumes that theowner has a "concrete project image" of the project,which includes requirements for hydrological enginee-ring, construction, energy management, and time-limits.

This requires considerably more extensive preliminarywork on the part of the owner in order to prepare theproject for tendering - this includes development of theconstruction areas, geological research etc...

This preliminary work and these basic conditions makesense in that they minimise many of the possible risks,and that the basic conditions (such as the location ofbarrages and tail race) are generally set in advance byfeasibility studies and general layout plans.

Experience in India, for instance, also shows thatwithout sufficiently extensive preliminary work by theowner, it is not possible to arouse sufficient interestfrom private investors.

For these preliminary works, the new Indian NationalPolicy on Hydro Power Development [4] has beenestablishing a National Power Development Fund,

which is financed by a new energy tax yet to be intro-duced, with the intention of accelerating the utilisationof the countrys large unused hydro power reserves.

Chenab river valley in J ammur & Kashmir (India)



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Introduction of innovation potential and know-how

Part of this model concept is the stimulation of inno-vation and know-how. The current tendency in hydropower construction by BOT is towards purely risk-minimised projects. Often, there is no risk-sharingwith regard to geological risks, and concession per-iods are too short, which means that there is no opti-misation of lifecycle costs. An example oflacking life-cycle optimisation would be the use of an upstreamfree-surface channel instead of a direct connectionthrough a pressure-tunnel. The tunnel would haveadvantages for future operating states (switching actions).

It is also an objective of the model concept that TBMsshould be used in the long tunnels mostly situated onthe critical path, thus reducing construction time withall consequences for lower financing costs and earlierrevenues from power production.

Expectations of the parties

The owner defines his expectations by a functionaldescription of the project, a geotechnical description(GBR - Geotechnical Baseline Report) on the basis ofa geotechnical database (GDB) that is as independentas possible from the construction method. Further-more, he informs the bidders of the qualitative resultsof his risk analysis and on that basis defines the finan-cial limit to which prospective bidders have to bearrisk. In our model, that limit is called "Maximum Bid-ders Responsibility - MBR".

The owners estimation of costs and risk analysis results in hisLEOW, as well as to the progress of his cost expectation. The owner

informs the bidders of the qualitative progress of this cost expecta -tion (=weighting function in assessing tenders) and of the Maximum

Bidders Responsibility (risk limit).

Maximum Bidders Responsibility - MBR

The Maximum Bidders Responsibility represents thefinancial limit from which it is the owner who will bearthe costs caused by the geology. But below that, thecontractor is responsible for his expectations to the

geology, i.e., the competitive tender remains effectiveup to the MBR (surcharge over the lump-sum price).

Graphic display of the remuneration and risk allocation under the

"K E F I R" model concept.

Lump Sum Expectation

The owner determines his Lump-sum Expection(LEOW), but does not tell it to the bidders. The licen-

ce biders in turn determine their own Lump-sumExpectation (LEB I), which represents a minimum

revenue (in the sense of Attribuable ConstructionCosts - ACC for the project). The area of differencebetween MBR and LEBI is integrated into the tender

by way of remuneration percentages.

Special cases

It is possible that there are cases in which the MBRhas been incorrectly stated by the owner. If theMBR has been stated to low, the incoming tendersof bidders will lead to a reconsideration of the pro-

ject idea. A MBR that is too high will most likelylead to relatively high remuneration percentages atthe beginning of the area of diff e rence, which areintegrated into the assessment of tenders and onlybecome relevant in the case of effective risk.

H o w e v e r, speculative bidders would suffer a highs h o rtfall of revenues until reaching the MBR.

In any event, setting the MBR is an instrument ofcontrol for realistic price determination.

Prevention of speculative tendencies

The model concept supports realistic price determi-nation with a clear allocation of risks and a limitationof risks by a gain/pain mechanism.

The bidder's Lump-sum Expectation represents aminimum revenue, even if conditions prove betterthan expected (bonus). In this case the contractorenjoys a higher profit.



CONTRACTS


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Risk is assumed by the contractor up to MBR,regardless of the nature of the event (exceptions arepossible in special cases), assumption of risk is sub-ject to competition, too optimistic (possible speculati-ve) expectations in competition are reduced by apain/gain mechanism during implementation.

Financial limitation of risk lower risk surcharges

necessary, easier financingwider range of interested

parties.

Generally lower risks due to more preliminary works.

Target Costing elements

The model shows elements of "Target Costing", twotargets being defined :

MBR as the limit to which risk is assumed (set byowner), LEBI as "upwards-adjustable Lump-sum

price" or minimum revenue (bonus mechanism),

The bidders offer a remuneration percentage for thearea of difference in accordance with their risk analysisand entrepreneurial decisions (tender by bidder).

The schedule for allocating any additional costs to theLump-sum price or lower costs compared with theMBR is not fixed as in a GMP contract but is subjectto competition by the bidders.

If the actual costs are situated in the area of difference,the contractor must bear the revenue shortfall in accor-dance with the curve of the remuneration percentageoffered by him.

Determination of best bidder

Since the expectations of owner and bidders regardsgeology at that time are of a subjective nature, amethod of assessing tenders under the requirementsof innovation, know-how and preventing speculativetenders must be defined.

Diagram to determinie the best bidder taking into account the rele -

vant tender components.

The best bidder is therefore determined from weightingthe following tender components :

Bidder's Lump-sum Expectation (LEBI),

Curve of remuneration percentage in the area ofdifference,Comparative calculation of the owner's expectations,which are determined using the bidder's prices on theowners geological expectations, Comparison of guaranteed performance and theconnected time-dependent costs.

At that time, the conditions encountered in excavating

are not known ; it is therefore impossible to decideobjectively which expectation is correct.

The weighting factors must be primarily set in a pro-ject-specific way. Furthermore, specific weighting canbe used to influence the amount of the Lump-sumprice in relation to other tender components.

Self-regulation mechanisms

If there is a negative deviation of encountered condi-tions from the owner's as well as the contractor'sexpectations i.e., if conditions are substantiallyworse than expected - the MBR is exceeded. Thecontractor must already bear his revenue shortfall

(including the geological risk up to the MBR).

Progress of the revenue shortfall (in % of turnover) depending onthe MBR selected, assuming that the Lump Sum Expectations of

owner and bidder are identical.

However, the worse conditions become, the lower thepro rata revenue shortfall of the owner gets.

Assuming that his prices cover his costs, his situation isbecoming better and better, the revenue shortfall is thusmitigated - following the idea that if conditions are total-ly different from what both parties assumed, it shouldnot be the contractor who should bear the geologicalrisk. Indirectly, this promotes cost-covering prices



CONTRACTS


19/42


20/42

AITES

ITA


of undergroundSpace





Geotechnical Risks for Project Financing of Tunnels in Non-Urban Areas

PROJECT FINANCING

Title

Topic

published

Abstract:

Rsum: Les conditions physiques et conomiques limitent l'importance des reconnaissances et des essais pralables laconstruction d'un ouvrage souterrain. Les donnes disponibles sont d'autant plus imprcises que le tunnel

construire est long, profond, de grande section, et que son environnement est complexe.

Remarks:

in "Tribune",


AuthorG. Lombardi


Others: Meetings


Nr. 20, pp. 19 - 23, Year 2001



21/42

INTRODUCTION

You may be happy to have to build a tunnel of up to adozen kilometres outside the urban area. You may thusavoid a number of problems like the archaeological onesor the crossing of existing sewage ducts. And, when thetunnel is deep enough - lets say a few hundred meters

below ground - you may also avoid arguments with theinhabitants of the city about vibration and noises or pro-blems of settlements of important buildings. If then bychance, the rock conditions are ideal, well known indetail and fit exactly the requirements of the TBM-equip-ment you have at hand and further more if any kind ofproblems with water or faults can be ruled out, then youwill be absolutely happy and lucky. I would then be plea-sed to congratulate you for the excellent business youare about to do - provided of course you got also a regu-lar price for. But, you will have to admit that these condi-tions will be more likely to represent the great exceptionthan the rules in tunnelling.

So, let us have a look at the main questions involvedin such underground works which are destined to betunnels for transportation, for the scope of conductionof water, any other type of fluid or energy, or cavernsfor any kind of human activities or finally to store anytype of goods.In doing so, we will only take into account the engi-neering aspects of the construction, not the electro-mechanical equipments nor the operation of complexactivities.

COMPLEXITY OF LONG DEEP TUNNELS

Deep tunnels are not just the extrapolation of shallowones. New aspects arise.A rock mass, which at shallow depths would behavein an elastical or, to some extent, in a plastic way, mayshow at depth completely different body-laws whereviscosity or the so-called "softening" may play themost important role.

In other circumstances, the best rock on the groundmay be affected at great depth by burst or spallingproblems and may turn out to be a very bad one. Insome cases the swelling of the rock mass, which isharmless at shallow depth may develop so to be a lotmore harmful there.

Not to mention the increasing water pressure, but alsothe increasing temperature, which can be significant-ly less than very comfortable.

Also, in spite of a great depth, one cannot be absolu-tely sure to escape environmental problems or argu-ments with the inhabitants or owners in the region.

Indeed, controversies on real or virtual problems can-not be ruled out. First of all, questions with thedepressing of the ground water table and the dryingout of springs, even if the tunnel is very deep, cannotbe completely excluded. But, one must also remem-ber the possibility of significant settlements due to thedraining of the mountain by deep tunnels, which canaffect some stiff structure on the ground like concretedams. At the reverse, an excessive internal waterpressure and losses from the tunnel may induceslides on the ground.

The excavation of the exploratory adit drained the ground waterentrapped in layer D, caused the settlement of the region anddamaged heavily the Zeuzier arch dam.

But, these are just a few of the special conditions,which may be met in a deep and long tunnel. The thirddimension, that is the axis of the tunnel also needs tobe looked at. This refers to the extension of each par-ticular zone of the rock mass and thus of the number,frequency and distribution of the changes as well asto the relative position and orientation of the variousdomains to be encountered, showing different pro-perties, state of stress or degree of alteration.


4 GEOTECHNICAL RISKS FOR PROJECT FINAN-

CING OF TUNNELS IN NON-URBAN AREASLes conditions physiques et conomiqueslimitent l'importance des reconnaissances etdes essais pralables la construction d'un

ouvrage souterrain. Les donnes disponiblessont d'autant plus imprcises que le tunnel construire est long, profond, de grande sec-tion, et que son environnement est complexe.

G. Lombardi


22/42

All the possible combinations - including obviouslythe most adverse ones - are to be duly consideredand only a few of them can be ruled out beforehand.The same story can be told on water, its flow rate,pressure and chemistry.

UNCERTAINITIES

Except in special cases - such as the drilling of a tun-nel parallel to an existing one at reduced distanceprovided of course similar methods of constructionare to be used as for the former one - an extremelygreat number of uncertainties must be accounted for

and introduced in the reasoning before starting withthe design of any important underground work.

If you have for example the splendid opportunity tooverfly the Alps on a clear sunny day, especially in win-tertime, you may be impressed by the overwhelmingbeauty of the landscape, but you may also becomeaware of the extreme morphological complexity of thismountain chain, whose shape includes a number offractal aspects. And, if you think that this extraordina-ry landscape just represents a kind of simple geome-trical expression or interpretation of the actual geo-technical complexity hidden below the ground - whichinter-pretation is governed by the relatively simplerules of the free field gravitational equilibrium - youmay have an idea of what a tunneller may encounter,excluding of course the magnificent wide view you canenjoy from your comfortable seat on the plane.

The problem for the tunnel designer can be statednevertheless in a very simple way and can be easilysolved. He has simply to express the synthesis of thiscomplexity by two possibly very precise numbers thatare "Cost and duration of the construction". Well! Thisis at least the opinion of the people who have to waitfor the tunnel and to pay the cost.

REDUCING THE UNCERTAINITIESThe main task for the designer is thus to try to reducesuch uncertainties. First aid is coming from the geolo-gist looking down from the surface to the futureunder-ground opening. Obviously, the deeper the tun-nel, the weaker the sight is and the more psychologi-cally coloured intuition is required and cannot be avoi-ded.

A certain support may possibly be found in formerstudies, investigations and construction records, butquite soon specific new investigations will be needed.Boreholes, shafts and adits may be of great help, pro-vided they can be really carried out and are not impe-

ded by some environmentally founded restrictions,specifications and difficult conditions, or even impos-sible, to fulfil, no matter whether they correspond tothe reality or are an alibi.

There is for sure no need to list here all the geological,geophysical, physical, chemical, hydraulic andmechanical methods and devices that can be used todefine in the best possible way, the geological, geo-technical, hydro-geological and geo-mechanicalconditions to be expected during construction.

Fortunately or unfortunately - depending on the pointof view - there is always somebody in charge of some

legal rule intended to limit the expenses due to suchinvestigation programs.

More exactly, the officially declared intention is toestablish an optimal costs-benefit balance. How riskythis exercise can be is due not that much to the factthat their costs may be underestimated, but to thefact that the benefits of the investigations are undefi-ned, by definition. Or, if you prefer the problem is animplicit one. This means that, you can often decidewhether the investigation was worthwhile or not, onlyonce it has been carried out.

Of course, even drilling a few hundred metres longborehole with the aim of just finding out how intensethe jointing of the rock in a short tunnel section is,may be considered a waste of money, because at theend of the day the result will not change the amountof rock supports actually required and placed.

On the contrary, the excavation of an investigationadit several kilometres long may turn out to be a rela-tively small investment, if it means avoiding great dif-ficulties during the construction of the tunnel forexample in slightly modifying its layout. The qualifica-tion of the rock mass remains a difficult task.

Different definition of the rock classes by two formulae.


4 GEOTECHNICAL RISKS FOR PROJ ECT FINANCING

OF TUNNELS IN NON-URBAN AREAS


23/42

Indeed, I know only a few cases where, after construc-tion, the investigations were considered as having beenexcessive, but many more cases where more investiga-tions would have been very useful in allowing a reduc-tion of the total cost and of the duration of the works.In spite of such quite theoretical exercises of optimi-sation, there is generally a "common sense" or intui-tion acquired with experience - which may at the endbe proven to be right or wrong - that leads to deci-sions going from a minimal number of short boreholesat the portals, to the drilling of a pilot adit all along thetunnel, depending on the supposed degree of uncer-

tainties and on the aim of the investigation campaignpossibly related to tendering and contractual aspectsor procedures.

But, no matter what you do as designer, at the end ofthe game the geological and geotechnical diagnosisand prognosis will always be considered - by theowner or by the contractor- as having been wrong.Again, some help will be offered by the geologist, whowill be pleased - I hope so - to share the responsibili-ties. Quite likely the engineers and geologists will besupposed to be responsible - at least morally - for anycost and time overrun, no matter what they decided,proposed or merely suggested.

In any case, there is obviously a reasonable limit tothe investigations and the analyses, which can be car-ried out or developed at design stage, so that as arule, the knowledge of the ground the designer canwork upon, will be severely limited and the numberand amount of remaining uncertainties will be signifi-cant, if not considerable.

FUZZY DATA BASE

Additionally, the data available are always known onlywith some approximation, so one can consider them,without any doubts, as being quite fuzzy, or in other

words, as forming a "fuzzy data set". On this fuzzy seta supposingly final design has to be based, whichshould lead to an exact definition of the costs and theduration of the construction. Thus, no wonder thatgeoengineering - which by the way includes not onlytunnels, but also dams and similar works - was calledthe "fuzziest of all the engineering branches".

By "geoengineering" one may in fact understand thebranch of civil engineering where the ground is not tobe considered only as one of the boundary condi-tions, let's say the underlying one, like the foundationof an usual building, but as a constitutive element ormaterial of the entire project itself. Obviously, this is

especially true for tunnels.

At the end of the day, and as a rule, this set will remainfuzzy in spite of the many efforts made to reduce itsfuzziness by field investigations or office computa-tions.

The uncertainty triangle (by Prof.Alberto Bernardini)

The consequence of this situation is that both designand construction methods must include a gre atamount of flexibility as well as adequate provisions in

o rder to face unexpected conditions under theground.

MONTE CARLO ANALYSIS

With few exceptions, the data forming the set are inde-pendent each from one another. A small exception is,for example, the fact that the lengths of the singlestretches must sum up to the total length of the tunnel.

Furthermore, one can assume that for each type ofrock only a certain set of geo-technical parameterscan apply.

On the contrary there is no reason at all, that, for

example, the width of single faults correlates in oneway or another with the friction angle in the disconti-nuities of the rock mass of other tunnel sections, whileboth values will of course influence, in the one or theother way, the total cost of the tunnel and theconstruction schedule.

As known, any element of a fuzzy set is supposed tobe defined by a minimum, a maximum and an "avera-ge", or most probable value, as well as by a densitydistribution of probabilities from the minimum to themaximum value. In general, this distribution is suppo-sed to be triangularly shaped with its peak at theassumed most probable value.


4 GEOTECHNICAL RISKS FOR PROJECT FINANCING



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The usual triangular-shaped assumption for the density of probabi-lity for a Monte-Carlo simulation.

In this respect one has to underline the fact that thisis no real reason at all for this distribution to assumethat shape. Also one must be aware of the fact that,as a rule, both limits as well as the most probablevalue are just the result of a process of estimation orguessing.

Apart from all the weaknesses of this statistical pro-cedure, it however appears to be the only way out ofa dilemma, and is a confirmation of the thesis that sta-tistics are the most pleasant and efficient way to hideour ignorance and to escape the quagmire of fuzzi-ness in singing a triumphant tune.

In fact, it is quite likely that no one will ever be unluc-ky enough to discover that all along the tunnel all theparameters will assume at same time the most unfa-vourable value. Or one may say, that the theoreticallypossible absolute worse combination is very unlikelyto occur. In the same way, also the absolutely bestcombination of conditions cannot be expected. Inreality however, even a worse than the worst expec-ted situation did occur from time to time !

Nevertheless, procedures based on a Monte Carloalgorithm can thus be used to define a plausible pro-bability distribution of such overall costs and durationof the project considering the internal compensations,

which are to take place. The scattering of the resultsaround the average is reduced sometimes to a quiteastonishing degree ; the compensation being of cour-se the more likely and effective the longer the tunnelis.

The probabilities obtained in this way may be veryuseful for the steps to follow during the developmentof the project, but do not eliminate the fact that thebase for design and construction remains alwaysfuzzy. Also a number of important aspects, like for ins-tance : the degree of optimism of the designer, apsychologically distorted proc e d ure in estimatingsome fundamental elements of the same set of pieces

of information, a non-suitable method of interpretingthe test results, or to compute the requirements ofrock supports, the use of a non-appropriate methodof construction, cannot be detected in using thesemethods, which nevertheless can be very useful inas-sessing the most probable results.

COMPUTATIONS

During the recent decades, the computationalmethods to solve civil engineering problems and espe-cially to analyse rock mechanic questions did developvery significantly. It appears that today no evident

mathematical limitation exists any longer in this field.

Flow chart of an analysis. Fuzzy data, fuzzy links and fuzzy results.

However, it is obvious that no computation can bemore valuable that the data used as in-put. Unfortu-nately, from time to time this aspect is ignored and

that the computation results are interpreted in a wayintended to hide more than to highlight this weakspot. Also the vague and fuzzy aspect of said inputdata-set is not duly enough taken into considerationin the computations themselves. This fact may lead tosome additional distortion of the overall results of anyrisk analysis developed on the base of a Monte Carlotype method.

GAMBLING, INSURING OR TRANSFERRING ?

Given this fuzzy situation, which can be made lessvague only to a quite limited extent, in carrying out





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additional investigations, more computations orMonte Carlo simulations, there are a number of posi-tions, which can be taken. They may be called : gambling with risks, assuming them, coveringrisks by insurance, sharing them with somebodyelse, or transferring them.

While keeping in mind that geoengineering is one ofthe fuzziest fields in civil engineer-ing. There is of cour-se nothing new, nor surprising when I say that nobodyis very keen to assume more risks than obliged andthat everybody would be happy to transfer them toother parties. Also insuring risks is indeed just another

means of transfering them, while gambling with therisks was at some time more used than it is today.

The problem is thus simply the following one. Which isthe best way to share the unavoidable risks betweenowners and contractors in order to optimise not onlythe project itself, but its overall economic impact, froma general point of view ? This means that not only thedirect financial expenses for the project should beminimised, but that the total real investment should bereduced to a minimum. For the general economy itmakes not much sense to reduce the nominal disbur-sements for a tunnel or similar works, while at thesame time other costs are to be assumed by the com-

munity like costs of accidents, damages, or unem-ployment due to a too irregular working load, or eventhe consequences of the bankruptcy of the contrac-tors involved.

I know however very well that any attempt to solvesuch a kind of problem is a pure illusion ! The problemthus simplifies somewhat and spells : which is anacceptable, reasonable risks sharing policy ?

CONTRACTING

Finally, this is a question of the contracting methodology.For a number of years there has been a strong ten-

dency to transfer the risks to the contractor as far aspossible and at the end all the risks, including the onesraising from unexpected geological conditions. Thistendency may be due to some former bad experience,but it is also favoured, by the increasing number ofeconomists, layers or accountants assuming manage-ment duties in the owner's organisations, replacingoften experienced engineers.

To go that way is for the owners, and possibly also forthe Engineer, an easy one, but it has already revealedsome drawbacks.

The first question raised is how long it will take until thecontactors will include in their prices an adequate pre-

mium for the risks they are supposed to assume or toinsure ? If additionally the contractor has to take careeven of the financing of the project, the role of the ownerwill turn out to be a very pale one. I don't know whethermany owners are really very keen to stay that much inthe background. In case the project may count on aneconomic return, the second question which arises isthus : what do we need an owner for any longer ?

Indeed, you may have noticed that worldwide anincreasing number of contractors turn to becomeowners themselves, for example, if toll-highways orpowerplants are involved. In doing so, they assume

obviously in addition to the risks of operation, not onlythat of construction, but they manage to simplifysignificantly the procedures.

I still believe therefore that in view of the real uncer-tainties and the remaining risk connected with anytunnelling activity, that an adequate way of sharingthese risks must be looked for. To try to include intocontractual documents an endless list of specialclauses reflecting any possible combination of condi-tions suggested by the century-long history of tunnel-ling is for sure not the right solution.

CONCLUSION

In conclusion, one must start from the principles that inany case contracts must be net, simple, precise, shortand fair. But, that in our field of activity they must must bealso as flexible as the design and construction them-selves are.

Extreme legal and burocratic complexity should hopeful-ly be replaced by an open and honest cooperation basedon simple rules, always keeping in mind the limited pre-dictability of the natural conditions under ground.

To try to found absolutely crisp contractual clauses on afuzzy data base, is very prone to lead to quite dramaticsituations resulting in less than optimal solutions, causing

high eco-nomic costs and additional delays, as it canalready be observed in an increasing number of cases. Insome occasions inadequate quality as well as risky ope-rations were also observed.

Due to ongoing legal procedures, such cases cannot bediscussed nor presented here in a more detailed manner.

The main conclusion however is that great improvementsof the present contracting praxis need be achieved if suc-cessful tunnelling, as well as a reduced activity in dis-putes, claims and lawsuits are desired.




Dr. Eng. Ph D.h.c. Giovanni Lombardi,Consulting Engineer, Minusio, Switzerland


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AITES

ITA


of undergroundSpace





Economical Feasibility and Project Financing in Urban Areas

PROJECT FINANCING

Title

Topic

published

Abstract:

Rsum: Le projet de rocade routire souterraine "Bastioni" Milan est un bon exemple des problmes de financementde projets en zones urbaines. Compte tenu de la trs forte demande de mobilit, la rentabilit financire de cette

opration est assure et il peut tre fait appel au financement priv.

Remarks:

in "Tribune",


AuthorG. Goggi


Others: Meetings


Nr. 20, pp. 24 - 28, Year 2001



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BACKGROUND OF THE BASTIONI PROJ ECT

Over the past years, as part of the debate on the urbanplanning and transportation network of Milan, severalassociations and individual technical specialists haveintervened with proposals for the use of the Bastioniring for the construction of an underground road. The

proposed projects were extremely varied, with somestressing single elements and others studying theentire ring, but all of them were characterised by theintent to use project financing procedures.

The Municipal Administration, stressing the obviouslypositive aspect of these proposals, decided to com-mission the Milan Underground in 1998 to study the"improved flow possibilities for the Bastioni ring"which also included, in the extreme case, the possibi-lity of constructing an underground road. The studyconsidered several scenarios, from the simple execu-t

Documents

TRIB 01 n20!4!36 Project Financing