Risk analysis in project

1. RISK ALLOCATION IN
INVESTMENT PROJECTS

2. INTRODUCTION
 Risk allocation means deciding which party of the Investment
contract will bear the costs or reap the benefits of a change in
project outcomes arising from each risk factor
 It’s a main way of achieving better value for money
 Types of risks that can be allocated include and not limited to;
land availability access and site risk, social risk, environmental risk,
design risk, construction risk, political risk, operating risk, financial
market risk, partnership risk, force majeure risk, and maga risk.
 Risks change depending on the type of investment project i.e
water project, roads project, energy project, ports project

3. GOALS OF RISK ALLOCATION
Creates incentives for parties to manage risks well and
thereby improve project benefits and reduce costs
Reduce overall cost of project risks by insuring parties
against risks they are not happy to bear
It increases project completion rates
It enhances private investor confidence in the project
and assures high returns with minimal chances of losses

4. RISK ALLOCATION PRINCIPLES
Each risk should be allocated to whichever party that can manage it
better. Managing a risk depends on;
 Ability to control likelihood of the risk occurring : For instance,
private party is usually in charge of construction since it has most
expertise in the area. As a result they should bear cost of
construction cost over-runs or delays. While government should
bear political risk of a government reneging on the contract.
 Ability to control impact of the risk on project outcomes: By
assessing and anticipating a risk well and responding to it. For
example risk of floods when constructing roads should be
anticipated in project design by a responsible firm with proper
mitigation in place.

5. RISK ALLOCATION PRINCIPLES
Ability to absorb the risk at lowest cost: If the likelihood and
impact of the risk cannot be controlled. A party's cost of
absorbing a risk depends on several factors, including; the
extent to which the risk is correlated with other assets and
liabilities, its ability to transfer the risk (Insurance) and
nature of its ultimate risk bearers. For example, the ability of
governments to spread the risk among taxpayers means
they may have lower risk bearing costs than private firms
whose ultimate risk bearers are their shareholders.

6. LIMITATIONS ON RISK ALLOCATIONS
 Level of detail of risk allocation: In theory every project risk could be
identified and allocated to the party best able to bear it thereby
improving value for money. In practice the cost of doing risk allocation
maybe high and likely outweigh the benefits in case of less significant
risks. In most cases risks are allocated in groups sometimes with
exceptions of certain significant risks. For example the private party may
bear all construction risks except for certain geological risks which
government will provide indemnity.
 Extent of risk transfer to private party: Lenders will typically accept only a
low level of risk, concomitant with their expected returns. If losses due to
a risk turn out to be greater than equity stake , equity holders can walk
away from the project. Thus government should take extra project risk to
assure shareholders of the private company.