QUT Research Week 2005

Conference Proceedings
Edited by A. C. Sidwell
45 July 2005, Brisbane, Australia

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The Queensland University of Technology

Research Week International Conference
4-8 July 2005
Brisbane, Australia

Conference Proceedings

Editor: A. C. Sidwell
July 2005

Published by:
Queensland University of Technology
Australia

ISBN 1-74107-101-1

RISK MANAGEMENT FOR PUBLIC PRIVATE

PARTNERSHIP PROJECTS AND PROJECT
PORTFOLIOS FROM AN INVESTORS PERSPECTIVE
Clemens Elbing1 and Hans Wilhelm Alfen
Chair Construction Economics, Bauhaus-Universitt Weimar, Marienstr.7, 99423 Weimar, Germany

ABSTRACT
Public Private Partnership (PPP) project arrangements are becoming popular all over
the world in the provision of public infrastructure, public real estates and public
services to include private sectors know-how, efficiency and capital.
Key issue of the paper is to present structured methods and tools for risk management
over the whole lifecycle of PPP projects and project portfolios.
A process model for risk management is developed from the developers/ investors
point of view including the steps identification, assessment, analyseation, allocation,
monitoring and control of risks as cyclic process over the whole lifecycle.
On one hand the developed software tool Portfolio Simulation (PSi) is presented
which allows the simulation of projects or portfolios cashflow/ economic indicators
(deterministic analysis) based on time schedules as well as the simulation of single
risks (sensitivity analysis) or cumulative risks (stochastic Monte-Carlo simulations)
on projects cashflow/ economic indicators. PSi can be applied for the simulation of
single projects, project portfolios, sub-portfolios or single projects in a portfolio.
As the model is based on schedules, risks are defined globally and allocated to every
single project with distribution functions, portfolio effects and cumulative risk effects
are modelled accurately.
On the other hand the application of simple methods and tools which can be used in
practice for quick investment appraisal and risk management exercises are presented.
These are often preferred in practice as time restrictions dont allow complex
simulations and estimated input data which is typically based on a number of
assumptions and consequently not accurate for complex stochastic risk simulations.
Keywords: cash flow modelling, lifecycle costs, project portfolios, public private
partnerships, risk management, sector specific risks.

INTRODUCTION
Public Private Partnership (PPP) projects are used in many developing as well as
developed countries around the world. For investors PPP projects are a new business
opportunity. Investors are typically contractors, operators, suppliers or strategic
investors. Contractors, who are typically in a lead position for structuring PPP
projects, can extend their value chain from planning and construction to services over
the whole lifecycle including planning, finance, construction, operation and
maintenance of facilities. If projects are structured successfully, investors can

clemens.elbing@bauing.uni-weimar.de

Elbing and Alfen

generate constant revenues over a long period which are independent of their
traditional cyclic businesses e.g. the construction industry.
The risk profile of PPP projects includes risks from the different phases of the
lifecycle; consequently the risk profile is extended in comparison to traditional
construction projects. Investors have to understand the risks profile, costs and value
drivers of PPP projects to invest successfully.
After a brief introduction to PPP projects, risk management and bundling of
portfolios, the paper presents a process model for risk management over the whole
lifecycle of PPP projects and portfolios from an investors perspective.
On the basis of interviews and benchmarking of available software applications for
risk management, a number of limitations of existing risk management tools are
summarised. The paper presents methods and tools for the different steps of the risk
management process. This includes simulations of schedules, cashflow, economic
indicators in deterministic analysis, sensitivity analysis and stochastic Monte-Carlo
simulations with the new software Portfolio Simulations (PSi) which is developed by
the authors.

PPP PROJECTS AND RISKS

PPP projects are long-term contractual arrangements between the public and private
sector for the provision of public services, infrastructure and public real estates.
Common characteristics of PPP projects are the long term nature of contracts, risk
transfer to the private sector, establishment of incentive structures to achieve
efficiency gains for the public sector over the whole lifecycle, project finance
transaction based on the predicted cashflow of the project and foundation of a special
purpose company (SPC) by the investors (Middleton and Davies 2002).
PPP projects can be tendered under a range of different contract strategies, major
differences of these are the amount of private sector involvement, risk transfer to the
private sector, ownership of facilities and payment mechanisms ranging from direct
user charges to public sector payments on the basis of output specified standards,
availability payments or annuity charges.
For investors, who are typically contractors, operators, banks or other strategic
investors, major difference to traditional public or private sector projects are the longterm nature of the project and their equity share in the project which is at risk.
Contractors are traditionally involved in planning and construction of projects, under a
PPP type of project arrangement, they are involved in planning, construction, finance,
operation and maintenance of facilities.
Relevant sectors for PPP projects
In order to structure a PPP business model over the whole lifecycle successfully,
investors have to understand and manage risks in a systematic way. Each PPP project
has a long list of possible risks including country and sector specific risks.
Relevant sectors for PPP projects can be categorised under the following groups of
infrastructure and public real estate projects (see figure 1). In order to start PPP
projects as a new business field, investors typically get involved in a limited number
of PPP sectors as they have to understand sector specific risks, cost and value drivers
over the whole lifecycle, extend their own know-how and link up with bidding
partners to fulfil required track-records in the pre-qualification process.

Risk Management for PPP projects and project portfolios from an investors perspective

Infrastructure

Transportation
Other systems

Tracks (net)
Stations
Transportation
Other systems

Water (net),
Harbours
Transportation
Other systems

Energy

Power, Gas,
Central heat

Water

Roads (net),
Bridges,
Tunnels,
Service stations

Generation,
Transmission

Drinking water,
Wastewater
treatment

Transportation
Other systems

Supply/disposal

Tele- Waste
Com.

Water

Track

Roads

Air

Transportation
Airports

Public Real Estates

...

Generation,
Treatment,
Distribution,
Sewers
Removal,
Disposal,
Elimination,
Treatment

Fixed nets,
Mobile nets

Administration
City halls
Ministry buildings
other plc. buildings

Health
Hospitals
Old peoples homes
Sanatoriums, ...

Leisure/culture
Sports facilities
Museums
Theatres,

Education
Kindergartens
Schools
Universities,

Security
Police buildings
Prisons
Frontier protection

Others
Fair areas
Others

...

Figure 1: Sectors for Public Private Partnerships (Alfen 2004)

On one hand PPP projects in infrastructure includes the sectors air, roads, tracks,
water and related services as well as projects in the sectors energy, water, waste,
telecommunication and related services (Alfen 2004). On the other PPP projects in
public real estates includes the sectors public administration, education, health,
security, leisure, culture and other buildings (Alfen 2004).
Definition of risks for PPP projects
Defining risks needs to be done in a context with a definition of chances and
uncertainties. Basically risks, chances and uncertainties are future changes of
parameters of a PPP projects business model with consequences on the schedule,
costs, revenues or quality standards over the whole lifecycle. Risks and chances can
be described with the parameters likelihood (in %), consequences (in EUR) and
duration of possible occurrence (Thompson and Perry 1992; Smith 1999). Risks have
a negative impact and chances have a positive impact on these parameters.
Uncertainties cant be described with these parameters as one or more of these are not
predictable.
To understand possible risks, chances and uncertainties of a PPP project is of crucial
importance for the public sector and bidding teams from the private sector in order to
structure a PPP project, the contract, risk allocation, output specification and payment
mechanisms (Arthur Anderson and LSE 2001).
In order to optimise a business model for a PPP project and achieve competitive
advantages, investors have to understand cost and value drivers of the project which
represent major risks, chances and uncertainties involved in a project.

Elbing and Alfen

Bundling PPP projects to project portfolios

In countries like the UK or Germany, PPP projects in the schools sector as well as
other sectors are now bundled to project portfolios, in order to reduce the overall
transaction costs and optimise the risk profile of projects. Portfolios can include either
projects from one sector, e.g. schools in one municipality, or a range of different
projects from diverse sectors, e.g. schools and public administration buildings.
To package project portfolios strategically is a major challenge now for the public
sector. In the schools sector to give one example, refurbishment and new construction
of projects have a different risks and chances profile over the whole lifecycle. New
construction of school facilities requires major upfront investments, refurbishment of
school facilities require lower upfront investments. The construction period for new
construction of schools is typically longer than for refurbishment of existing school
facilities. As the generation of revenues of PPP schools starts with the operation
phase, refurbishment projects can generate revenues earlier in comparison to new
constructed school facilities. New school facilities can be optimised for low lifecycle
costs; the existing building structure of refurbishment schools on the other hand offers
just little flexibility for optimising lifecycle costs.
To manage risks of PPP project portfolios effectively has new requirements for
investors. The effect of cumulative risks and portfolio effects on the portfolios
cashflow must be modelled accurately.

RISK MANAGEMENT PROCESS FOR PPP PROJECTS AND

PORTFOLIOS
Contractors and other investors in PPP projects have to manage risks of PPPs over the
whole lifecycle in a systematic way in order to structure a business model for a PPP
project successfully, to achieve a predictable and save return on their investment. In
this chapter a risk management process (see figure 2) is presented and limitations of
existing methods and tools are summarised. In the following chapter methods and
tools for steps of the process model are presented including the new software tool
Portfolio Simulation which fulfils some of the identified limitations of existing tools.
Risk management process
The following risk management process (see figure 2) presents a process model for
the identification, assessment, analyseation, allocation, monitoring and control of risks
over the whole lifecycle of PPP projects from an investors perspective.

Risk Management for PPP projects and project portfolios from an investors perspective

Identification

Assessment

Analyseation

Allocation

Allocate risks

Develop list

Appraisal of

Test robustness

- global
- sector specific
- project specific

- likelihood
- consequences
- period

- projects
- sub-portfolios
- overall portfolio

- Checklists, indicators
- brainstorming
- workshops
- priority list of risks

- Deterministic
analysis
- sensitivityanalysis
- Monte-Carlosimulation

- transfer
- avoid
- reduce
- insure
- or take risks

Contracts
including
- output
specification
- payment
mechanisms

Monitoring/
control
externally
internally
- concept/ strategies
- clear responsibilities
- monitoring/ audit

- Contractsmanagement
- Controllinginstruments

Cyclic process over the whole lifecycle

Figure 2: Risk management process

On top of the process model (see figure 2) the different process steps and activities are
presented. On the bottom of the process model (see figure 2) the utilised methods and
tools are presented.
The application of a systematic process model ensures that risks are understood and
managed over the whole lifecycle in a systematic and structured way in order to invest
in PPP projects successfully.

LIMITATIONS OF EXISTING METHODS AND TOOLS FOR

RISK MANAGEMENT
So far the risk management process is often described in three steps including
identification, analyseation and management of risks (Thompson and Perry 1992;
Smith 1999) as cyclic process. In order to manage risks of PPP projects and certainly
project portfolios over the whole lifecycle successfully, the process model needs to be
extended according to the presented process model (see figure 2) including the steps
identification, assessment, analyseation, allocation, monitoring and control of risks as
cyclic process over the whole lifecycle.
From the authors point of view methods and tools for the analyseation, allocation,
monitoring and control of risks over the whole lifecycle still have limitations and can
be improved. The following limitations of methods and tools for risk management are
identified by interviews with investors and in a benchmarking of existing software
applications:

Elbing and Alfen

Financial models for PPP projects are often not based on a time schedule,
consequently effects of risks on the schedule, dependencies and correlation
effects cannot be assessed

The time frame for costs, revenues and risks are not included in the model

Risk effects are modelled with pre-defined risk scenarios or with sensitivity
analysis (variation of one parameter in the business model)

The distribution of risks and effect of cumulative risks under variation of all
parameter (e.g. with Monte-Carlo Simulations) is applied just for a few
projects

Portfolio effects are not modelled accurately (certainly dependencies,

correlation and cumulative risk effects)

There is no commercial software tool available to model the cashflow of PPP

project portfolios on the portfolio level, sub-portfolios and single projects

There is relatively limited knowledge about the risk profile over the whole
lifecycle, software tools do not offer user interfaces to visualise the risk profile
over the whole lifecycle

Costs for transferring risks are not modelled

METHODS AND TOOLS FOR RISK MANAGEMENT

Risk identification
The first step of the presented process model (see figure 2) is to identify risks, typical
country, sector and project specific aspects must be addressed. Risk identification
should be done with people from all involved parties and can include extern experts
who have certain experience in the country, sector or for the specific project. The
identification exercise can be done with checklists, in workshops or brainstorming
sessions.
Risk assessment
After risk identification, the parameters likelihood, consequences and possible period
of occurrence must be assessed for each risk. Consequences of risks can be on costs,
revenues or activities of the projects schedule (Thompson and Perry 1992). In an
early stage the likelihood and consequences can be assessed qualitatively e.g. on a
scale from A to E (A very low, B low, C mean, D high, E very high) and later the
likelihood can be assessed in percentage and consequences in monetary terms.
Risk analyseation (qualitative)
The qualitative risk assessment on an A to E scale can be used to transfer long intransparent risk lists into a priority list of risks using a scoring-risk matrix (see figure
3). Once risks can be assessed in more detail or exact in percentage (likelihood) and
monetary terms (consequences), the applied scores can be adjusted.
Decision makers can develop a scoring-risk matrix e.g. with a score from 1 to 10 (see
figure 3), if a risk X is predicted with likelihood B and consequences B the score is 2,
if a risk Y is predicted with likelihood C and consequences E the score is 9, if a risk Z
is predicted with likelihood E and consequences E the score is 10. Consequently Z
has the highest priority with the score 10, followed by Y with a score of 9 and X with
a score of 2.

Risk Management for PPP projects and project portfolios from an investors perspective

Consequences
5

10

10

X
1

Likelihood
Figure 3: Scoring risk matrix to transfer risk list into priority list

The example with three risks (X, Y, Z) is a simple example, but as risk lists for
complex PPP projects such as PPP school portfolios can be very long the application
is effective support for decision makers to look after risks in a clear order starting with
the important risks involved in a project.
The presented scoring-risk matrix can be used as well to prioritise risks for the
different phases of the projects lifecycle and to develop a risks-chances profile over
the whole lifecycle e.g. to identify potential risks and chances at different points in
time to find strategic exit options for investors.
Risk analyseation (quantitative)
In order to model the effects of risks accurately a quantitative analyseation of risks in
a financial model is necessary for investors. In the past contractors used global risk
adjustments e.g. by adding 10% contingencies to a bid price which is not sufficient for
PPPs as complex long term investments with and extended risk profile.
An improved approach is to add risk contingencies to major cost and revenue centres
in a PPPs financial model. Even if this approach is more accurate than adding global
risk contingencies, the effect of cumulative risks is not addressed accurately. Scenario
techniques are often applied by changing major cost and value drivers in the financial
model to develop the so called best case, most likely case and worst case scenarios.
Even if these are different scenarios presenting the up- and down-side potential of
projects by changing more than one parameter in a business model, there are always
risk combinations which will result in scenarios worth than the so called worst case
scenario or better than the best case scenario. Experienced decision makers might get
a clear understanding of a project with scenario techniques, however this approach is
still a simple try and error technique to analyse a project. For project portfolios with

Elbing and Alfen

complex cost, revenue and risk structures scenario techniques are not sufficient to
analyse the effects of risks.
There are a number of software tools available such as @Risk, Crystal Ball, InfRisk or
spreadsheets in Microsoft Excel which can be used to analyse PPP projects risks.
Tools like @Riks or Crystal Ball offer a number of distribution functions to include
the effect of risks in a possible range instead of a single value. Typical distribution
functions are the normal, triangular, uniform, lognormal and exponential distribution.
These tools can be utilised to run sensitivity analysis and Monte-Carlo simulations to
analyse the effect of single risks and cumulative risks according to selected
distribution functions for every single risk. However these tools still have some of the
identified limitations, certainly as dependencies, correlation and portfolio effects of
risks cannot be modelled accurately.
To the authors knowledge there are not any risk modelling software tools available for
project portfolios where risks are defined globally but allocated for each project with a
distribution function which is implemented in the new software application Portfolio
Simulation (PSi).
PSi is a cashflow modelling tool for projects and project portfolios based on projects
time schedule. Decision makers have to define the following input data of a PPPs
projects portfolio to develop a financial model in PSi:
-

portfolio name, start or end date and basic time unit

every single project with its project name, activities/duration/dependencies in a

schedule

every single projects costs and revenues (fixed, time related, even distribution,
quantity proportional) linked to activities

portfolio costs and revenues (fixed, time related, even distribution, quantity
proportional) which cannot be allocated to single projects of the portfolio

risks are defined globally for the whole portfolio and allocated on the projects
level with distribution functions and dependencies

inflation lines and discount rates can be added

PSi can be used to develop the following output data for every single project, subportfolios and the overall portfolio:
-

time schedules

cashflow (see figure 4), economic indicators in deterministic analysis

sensitivity analysis (see figure 5)

distributions from stochastic Monte-Carlo simulations (see figure 6)

The first version of PSi is implemented to overcome some of the identified limitations
of existing methods and tools for modelling PPP projects and project portfolios risks.
As financial models in PSi are based on time schedules and allocated costs/revenues,
effects of risks can be modelled on the schedule, costs and revenues. Risks are
defined globally and can be allocated to every single project with distribution
functions to model dependencies, correlation and portfolio effects accurately. All
deterministic, sensitivity and stochastic Monte-Carlo simulations can be used on the
portfolio, sub-portfolio and project level.

Risk Management for PPP projects and project portfolios from an investors perspective

Figure 4 presents the discounted (Figure 4 line 2) and undiscounted (Figure 4 line 1)
cumulative cashflow (in EUR) for a portfolio of 29 schools modelled in PSi.

Figure 4: PPP project portfolios cashflow (NPV in EUR over time in months)

Risk analyseation sensitivity analysis

Sensitivity analysis can be used in PSi to model the effect of single risks on the
cashflow, certain economic indicators or activities in the schedule of one project, subportfolios or the overall portfolio at specific pre-defined milestones during the whole
lifecycle.
The following figure 5 presents a sensitivity diagram for a portfolio of 29 schools. In
the diagram the effect of four risks (construction costs of one single school,
refurbishment costs of one single school, operation costs of one new school, operation
costs of one refurbished school) on the NPV at portfolio end (of the overall portfolio)
is visualised in the range of -20%+20% variation of each risk.

Elbing and Alfen

Figure 5: Sensitivity analysis

Risk analyseation Monte-Carlo simulations

As cumulative risk effects cannot be understood by decision makers for complex PPP
project portfolios, the application of stochastic Monte-Carlo simulations is often
required but just little used in practice. The following figure 6 presents three
distribution curves for the NPV of a portfolio of 29 schools as result of stochastic
Monte-Carlo simulations. The first S-curve (see figure 6 line 1) presents the possible
range of NPV at the milestone 2015 before negotiating risk allocation (95%-range in
between EUR -36.55Mio. and 40.88Mio.). The third S-curve (see figure 6 line 3)
presents the possible range of NPV at the milestone 2015 after negotiating risk
allocation with all contracting parties of the special purpose company (95%-range in
between EUR -36.22Mio. and 39.41Mio.), the second S-curve (see figure 6 line 2) is
at one step during the negotiations.

Risk Management for PPP projects and project portfolios from an investors perspective

Figure 6: Monte-Carlo simulations

Stochastic Monte-Carlo simulations can be used in PSi to model the range of

economic indicators (discounted or undiscounted NPV, IRR, ROI, ROE, payback
period, or other economic indicators) or activities from the time schedule (e.g.
completion of construction, start of operation or end of concession) for single projects,
sub-portfolios or the overall portfolio. Simulations can be run for different predefined milestones over the whole lifecycle.
Risk allocation
A first proposal for risk allocation between the public sector and SPC is given with the
tender documents including a contract draft with its risk matrix, output specification
and payment mechanisms. However investors have to optimise risk allocation
between the public sector and other contracting parties like the contractor, operator,
major suppliers and their sub-contractors in order to maximise their return on equity
and the range of possible outcome of the project.
The risk management principle that every party should take risks that he can actively
manage and control must be understood by all parties who are involved in order to
share responsibilities, risks and establish incentive structures. Risks can basically be
taken, transferred, avoided or insured under. Ideally all risks which are transferred to
the SPC should be transferred from the SPC to other contracting parties mainly the
contractors, operators and suppliers to reduce the range of economic indicators and
volatility of the cash flow. This will lead to lower margins allocated to projects debt
and mezzanine capital as well as a lower debt/equity ratio requested from banks.
Monitoring and control of risks over the lifecycle
Once contracts are signed the SPC has to monitor all contracts (external monitoring)
and control (internally) risks over the whole lifecycle. Risks and chances can occur

Elbing and Alfen

just during a certain time frame (e.g. during planning, construction or operation
phase), so the risks list must be controlled and updated regularly.
An understanding of the risks and chances profile over the whole lifecycle is of crucial
importance to understand a PPP project and optimise the investors business model
including their investment and exit strategies. Exit strategies can include refinancing
and restructuring projects or portfolios.

Risks profile (qualitative score)

The different benchmarked software applications do not offer any graphical user
interfaces to present the risks profile over the whole lifecycle of PPP projects and
portfolios. A qualitative analysis of the risks profile of PPP projects can be
implemented with the qualitative analysis in the described scoring-risk matrix. If risks
of a PPP project or portfolio are analysed e.g. in annual steps over the whole lifecycle
by applying the qualitative risk assessment and qualitative scoring-risk matrix, one
can develop a risk profile over the whole lifecycle. The following figure 7 presents a
qualitative risk profile for a PPP projects portfolio.

100
90
80
70
60
50
40
30
20
10
0
1

11

13

15

17

19

21

23

25

27

29

Contract period in years

Figure 7: Risk profile over the lifecycle

In the next version of PSi a graphical user interface for the risks and chances profile
will be included on the basis of a value at risk simulation over the whole lifecycle of
projects and project portfolios.

CONCLUSION
PPP projects and project portfolios are a new business field for contractors, operators,
suppliers or strategic investors. They offer an extension of the value chain over the
whole lifecycle of projects including planning, construction, finance, operation and
maintenance of facilities. Investors have to understand and optimise PPP projects
risks and chances profiles in order to structure projects with a predictable return on
their investment. Optimising the risks profile and reducing the volatility of projects
cashflow offers investors a competitive advantage, reduces costs of finance and
maximises their return on equity.

Risk Management for PPP projects and project portfolios from an investors perspective

The paper presents a process model for risk management including identification,
assessment, analyseation, allocation, monitoring and control of risks over the whole
lifecycle. Every step is described with typical methods and tools.
Existing software applications have a number of limitations, certainly for accurate
modelling of cumulative risks, correlation of risks and portfolio effects under
application of distribution functions for all risks.
The developed software tool PSi can be used to model the schedule, cashflow,
relevant economic indicators, effects of single risks and cumulative risks for PPP
projects and project portfolios. PSi can be used to optimise and level sources of
finance, costs- and revenue structures, the risk profile and gives investors a better
understanding of PPP projects and project portfolios. By defining risks on a global
basis and linking them to every single project in a portfolio with distribution
functions, it is the first software application to model cumulative risks, correlation and
portfolio effects accurately. Future versions of PSi will be extended with offer
functionalities and user interfaces according to investors needs.
By using a qualitative assessment and scoring-matrix at different milestones over the
whole lifecycle a qualitative risk profile is presented in this paper. A future version of
PSi will also include a quantitative risk profile over the whole on the basis of a value
at risk model calculated at different milestones over the whole lifecycle.
The application of PSi for modelling PPPs schedule, cashflow and risks must be
limited that the output of any simulation is as good the input data. Decision makers
need to understand PPP projects and portfolios as well as the presented process model
and have to test results with plausibility checks in order to use PSi modelling as
effective support. For early phase investment appraisal or if the available input data is
not accurate simple tools and techniques should be preferred like the presented
scoring-risk matrix, scenario analysis or risk adjustments with contingencies.

REFERENCES
Alfen, H.W. (2004) Lecture notes Public Private Partnerships and Project Finance. BauhausUniversity Weimar, Germany.
Alfen, H.W.; Elbing, C.; Leupold, A. (2005) Payment Mechanisms for Public Private
Partnership Road and Highway Projects. Infrastructure Journal, issue may 2005.
Arthur Anderson and London School of Economics (2001) Value for money drivers in the PF.
Merna, A. and Njiru, C. (2002) Financing Infrastructure Projects. Thomas Telford, London
Middleton, N. and Davies, P. (2002) Public Private Partnerships A clearer view.
PricewaterhouseCoopers Report.
Smith, N.J. (1999) Managing Risk in Construction Projects. Blackwell Science Ltd., Oxford.
Standard and Poors (2005) Rating Methodology for Global Power and Utilities.
Thompson, P. and Perry, J. (1992) Engineering Construction Risks. Thomas Thelford,
London.