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2.7 Risk associated to industrial projects
During all project phrases exists the possibility that project conditions change, partners fail, suppliers do not perform or the market developments are not as expected and unfavourable to the project economics.
From the point of view that everythingthat endangers the investor’s intention and expectation for the projects success is a risk, its identification can be approached from the dimensions of effect and origin17, and the possibility of control (being systemic and unsystematic)18.
| Risk dimension | Effect | Origin |
|---|---|---|
| Downside risk | Business failure | product substitution, technology failure, non completion, availability of feedstock |
| Volatility risk | Insolvency (illiquidity), low Cash flow, | Product prices, less market growth/ stagnation, economic situation |
| Strategic risk | Profitability | Competiveness, supplier or partner failure, market growth/ stagnation, production capacity, change of law, days of production, plant efficiency, Cost overruns, Construction delays, |
Table 6: Risk dimensions in industrial projects19
Following a systematic approach underlying the CAPM20 theory, risk can be classified into systematic and unsystematic risk21.
Systematic risk stands for uncertainty faced by all market participants active in the specific market (e.g. government policy, business cycle, acts of nature) and therefore cannot be limited through diversification within the same market.
Unsystematic risk is specific risk that can be diversified as only specific market participants or industries are affected and thus can be counterbalanced.
| Systematic (not diversifiable risk) | Unsystematic (diversifiable risk) |
|---|---|
|
|
Table 7: Systematic and unsystematic risk in industrial projects23
If allocated to the project phases the value at risk can be illustrated as demonstrated in diagram 6.
Value at risk over project life time" class="wp-image-11361 size-full" height="253" src="https://sgbs.ch/wp-content/uploads/Illustration-5-Value-at-risk-over-project-life-time.png" width="432"> Illustration 5: Value at risk over project life time
The highest amount of capital is at risk just before the project starts operation as only expenditures have been made to complete the project, until this date no revenue or other return could be achieved. This maximum value at risk is significantly reduced in the further progress of the project as during the first period of production the technology proves performance, production capacity and product quality. As soon as the test runs have been completed and a certain period of flawless production could be achieved, the risk of completion and the risk of technology has been overcome (or realized). Until all debt is repaid financial risk exists in form of debt service capacity.
17 Volckart p 931
18 Böttcher, Blattner p 146, 147
19 Volckart p 931
20 CAPM means Capital Asset Pricing Model
21 Böttcher, Blattner p 141
22 In case of projects with natural resources as feedstock the supply risk is also systematic
23 Cf Böttcher and Blattner, page 43; Finnerty, page 76ff