Risk flexibility analysis in infrastructure project finance

Successful implementation of infrastructure project financing depends on how risk is approached by the Sponsors and the Financiers. Construction completion and demand uncertainties are particularly important risks in infrastructure funded using project financing. One possible way to deal with these uncertainties is to implement a collection of flexibilities into projects in a way that mitigates risk to an acceptable level, and enhances project economics when uncertainty reveals to be favorable. Many recent studies have focused on individual flexibility rather than on a collection of flexibilities. Several risk analysis frameworks can perform a quantitative risk analysis in the construction and operation phases. However, they assume the construction period to be deterministic, neglecting the repercussions of completion delay on operational phase risks, such as revenue risk. Moreover, current models of completion risk analysis ignore project managers' ability to react to negative events. These shortcomings provide an opportunity for the research to (1) explore methods for capturing flexibility values into the analysis and (2) develop an integrated risk analysis framework for valuing a project with a collection of flexibilities. This research presents a theoretical framework of Risk Flexibility Analysis (RFA) that combines construction risk analysis with operational risk analysis. The RFA provides a systematic, flexible approach to valuing a project with a collection of flexibilities, which is presented using a networking approach. In addition, it is capable of capturing interactive values among the flexibilities in a collection. Within the RFA framework, a novel approach for modeling construction completion risk is developed by combining the Stochastic Critical Path Method with Envelope Method (SCP-EM). The SCP-EM method can model the option-like feature of management feedback reactions during construction in a straightforward fashion. A BOT toll road project illustrates the application of the RFA. The results show that certain collections of flexibilities provide additional values created by interactions among flexibilities in the collection. The framework of the RFA can be incorporated into current software applications for infrastructure project appraisals, and applied to other projects similar settings to PPP infrastructure projects. Furthermore, the analytical tool SCP-EM can be used for completion risk analysis of any type of projects in which management feedback is assumed to occur during project execution.