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1 INTRODUCTION
This section describes the major project management techniques necessary for the evaluation, planning, monitoring, and control of transmission and distribution projects. It looks at the situation primarily from the point of view of the client or distribution company management. In particular, this section explains the importance of correct definition of the work to be performed together with the need for a mature approach to the client/consultant/contractor relationship.
A project definition/questionnaire is included in Appendix A (below).
Engineers may feel that high-engineering standards and excellence in design should be the major factors in the award of contracts. It is a fact of life that in a highly competitive environment good design is only a part of the overall project process. Another way of looking at it is that good engineering design is that which provides best value for money. Indeed even compliance with the specification may be of secondary importance if the contractor is able to offer alternative equally viable schemes with substantial cost savings. Over specification helps no one. Low price, whole-life cost, short and certain delivery, and low cost financing are also major factors that lead to the success of the project from both the client's and contractor's point of view.
2 PROJECT EVALUATION
2.1 Introduction
The electricity supply company and the network operating company (which may be a separate organization) must satisfy demand for power by the consumer and obtain sufficient revenue from sales to meet investor requirements and future expansion plans. In order to achieve these goals, investment in generating, transmission and distribution plant is necessary. Money on capital projects is spent now in the hope or expectation of sufficient returns or profit at a later date in the future. Investment may be for:
_ Replacement of equipment possibly to reduce maintenance costs (cost reduction) _ Fig. 1a.
_ Expansion of transmission or distribution capability to reach more customers _ Fig. 1b.
_ Provision of new products.
The problem is to find 'good' projects by imagination, alertness and creativity (plus a degree of luck) in order to spot the investment opportunity.
Imagine, for example, the problems that international aid agencies might have in trying to identify a 'good' project. They will be inundated with different schemes for projects but only a small number will be viable and be capable of bringing about the required benefits. It is necessary to look at both the financial and the economic costs and benefits of the project before a final investment decision may be made. Financial project investment assessments look at the project purely in monetary terms. Economic appraisals look beyond this and include such intangibles, converted to money terms, as general benefits to the community that the project will bring about. For example a distribution scheme might allow the community to stop chopping down trees for fuel (thereby saving for example the environment from soil erosion) and thus allow greater productivity in the community.
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FIG. 1 (a) Cost reduction project; (b) expansion project.
(a) (b) Time; Net income; Costs (£); (£) Time; Without project; With project; With project; Without project
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2.2 Financial Assessment
2.2.1 Annual Rate of Return
This simple appraisal method looks at:
_ Initial investment.
_ Total cash inflows resulting from the project.
_ Average annual profit.
The annual rate of return project appraisal method is simple, easy to understand and a good guide to the profitability of a capital project investment.
Consider the two projects X and Y below:
Project X Project Y (d3106 )(d3106 ) Initial investment (End of year [EOY] 0) 26 212 Cash inflows from project (EOY 1) 13 17 Cash inflows from project (EOY 2) 14 18 Cash inflows from project (EOY 3) 18 19
1. Total cash inflow 115 124
2. Total net profit 19 112
3. Average annual profit 13 14 4.
Average annual profit
Initial investment
3100% 3/6550% 4/12533%
Project Y has higher total cash inflow (d243106 vs. d153106).
Project Y has higher total net profit over 3 years (d123106 vs. d93106 ).
Project Y has higher average annual rate of return or profit (d43106 vs. d33106 ).
Project X has higher rate of return on investment (50% vs. 33%).
The averaging process, however, eliminates the possible important and very relevant information about the timing of the cash flows involved with the investment. For example, consider two further Projects V and W:
Project V Project W (d3106 )(d3106 ) Initial investment (EOY 0) 26 26 Cash inflows from project (EOY 1) 11 16 Cash inflows from project (EOY 2) 12 12 Cash inflows from project (EOY 3) 16 11
1. Total cash inflow 19 19
2. Total net profit 13 13
3. Average annual profit 11 11 4.
Average annual profit Initial investment 3100% 1/6517% 1/6517%
The cash inflows for the two projects are in reverse order with Project W recouping the initial investment sooner than Project V. The average annual rate of return on investment appraisal method for each project, however, gives the same assessment for both Projects V and W. The useful earlier recouping of monies is not immediately apparent from this appraisal method. It is certainly feasible that the early cash generation from Project W could be put to good use elsewhere. Under Project W, the extra d5,000,000 received in year 1 compared to Project V could be invested on the capital markets to yield further gains. Taking into account the 'opportunity cost' of capital, Project W is superior. This is a typical example of the importance of cash generation for the contractor in construction projects. Generally construction yields quite low profit margins but the money sums involved are often large.
Comparatively little capital is tied up in plant in comparison to the manufacturing industry. The cash generated from the construction project is therefore reinvested by the construction company in other areas yielding higher returns.
2.2.2 Payback
To allow for the timing of returns from the project, the payback method of assessment may be used. Again this is a simple project financial appraisal method which indicates how many years it will take before the original amount invested in the project is 'paid back' _ i.e. the time before cumulative returns exceed the initial investment with generally the shorter the period the better.
Consider two Projects S and T with the same initial investment as shown below.
Project S Project T (d3106 )(d3106 ) Initial investment (EOY 0) 26 26 Cash inflows from project (EOY 1) 13 18 Cash inflows from project (EOY 2) 14 15 Cash inflows from project (EOY 3) 18 12
1. Total cash inflow 115 115
2. Total net profit 19 19
3. Payback period (years) 1 3 4 3 4
Whilst the payback method of assessment has taken timing into account it still does not consider the maximum acceptable payback period. The method ignores cash receipts expected after payback; but this, for the longer term thinker, could be very important. For example, although Project T above has a much quicker payback period, the receipts from the project over the years seem to be diminishing, whereas, those from project S are on the increase. The method is therefore a rough screening device and a measure of risk associated with this project. The method does not inform the investor about the overall profitability of the project.
2.2.3 Discounted Cash Flow
In order to better forecast and analyze a particular project investment, more information about both the amounts of cash generated and the timing involved is required. Having said this no method of analysis gives a precise answer or avoids the risks involved. The timing assumed in the analysis may not be correct, the forecasted cash quantities may be inaccurate, the opportunity cost of capital may vary as interest rates and tax regimes change during the life of the project, and non-financial aspects (cost-benefit analysis, political upheaval, etc.) all need to be considered. A most important point is to remember that the cost of the analysis and the time to complete it must be kept in check and should not exceed the benefit obtained from it. In accounting terminology, this is known as the 'materiality concept'.
The time value of money is nowadays generally understood since inflation is a topic much covered in the news. Money will depreciate in terms of its purchasing power over time if the inflation rate is higher than the returns received from investment. d100 invested at 10% annual interest over a 3-year period will have a 'future' value of d133.10 at the end of 3 years. The 'present' value of this investment (without considering reductions in purchasing power due to inflation) is therefore d133.10 as calculated below:
EOY 0 d100.00 EOY 1 d100.0031.15 d110.00 EOY 2 d110.0031.15 d121.00 EOY 3 d121.0031.15 d133.10
When comparing the cash returns over time from different project investment options at a given discount rate the higher the Net Present Value the better.
Consider d10,000,000 invested now in Project R to yield returns of:
13,000,000 at EOY 1 14,000,000 at EOY 2 15,000,000 at EOY 3
Should the distribution company on purely financial considerations make this investment or simply bank the money at 10% interest per annum? d10,000,000 invested for 3 years at 10% p.a. will yield d13,310,000.
In comparison with the above value, the individual End of Year cash returns, without allowing for depreciation of money over time, is a total of d12,000,000. These cash flows may be converted to an equivalent EOY 0 value totaling d9,786,000 by applying a 10% discount rate as shown.
From this analysis it can be seen that the returns over a 3-year period are not enough to justify the investment in Project R, since with the 10% opportunity cost of capital, it is better to more safely invest the monies elsewhere.
This may not be the most important factor for a publicly owned utility, but it is a very relevant approach in the case of a privately funded or joint public/ private finance project.
TABLE 1 shows the present value of d1.00 receivable at the end of n periods. Thus, given an interest rate of 15% per annum, d1,000.00 receivable at the end of 5 years (end of year 5 or EOY 5) may be calculated from the table by applying the appropriate discount factor to give a present value of d497.00.
TABLE 1 Present Value of d1
TABLE 2 Present Value of d1 Received Annually for n Years
TABLE 2 shows the present value of d1.00 per period receivable at the end of each of the next n periods. Therefore for an interest rate of 15% per annum, an 'annuity' of d1,000.00 over 5 years has a total present value of d3,352.00. This figure could also be derived from TABLE 1 by adding the individual discounted values of the d1,000.00 received each year. For example,
EOY 1 present value5 d870 EOY 2 present value5 d756 EOY 3 present value5 d658 EOY 4 present value5 d572 EOY 5 present value5 d497 d 3,353
An alternative measure of the financial acceptability of the project using discounted cash flow techniques is to assess the project's internal rate of return (IRR). This is the discount rate that exactly reduces the net present value to zero. The higher the IRR the better the return is considered to be on the investment. For the above project R, the IRR will be less than 10%. With a discount rate of B8.9%, the NPV is almost zero. Hence, it can be immediately seen that investment in a bank with an interest rate of 10% is a preferable option. Again, this analysis tells us nothing about cash flows beyond the 3 year period. It should be noted, however, that in the longer term (and over 25 years in the case of the 10% discount rate) cash flows, in far into the future, have little present day value.
End of Year (EOY) Cash Flows (d) Discount Factor at 10% (see TABLE 1) Present EOY
0 Value (d) Resultant NPV (d)
0 210,000,000 1.000 210,000,000 210,000,000 1 13,000,000 0.909 12,727,000 9
=
; 2 14,000,000 0.826 13,304,000 19,786,000 3 15,000,000 0.751 13,755,000 Net present value52214,000
2.2.4 Sensitivity Analysis
Obviously, the end result of any such financial analysis can only be as good as the input data and original assumptions. Items such as interest rates, cost of materials, exchange rates, and inflation may all change during the life of the project and may have an effect on the viability of the project. For the more sophisticated analysis the sensitivity of the results to such changes are considered. With the use of spreadsheets on modern micro computers the cash flows are entered into a table and the NPV or IRR calculated.
Variations in parameters can then be altered with the computer doing all the calculations to allow the effect of such changes to be assessed. A graphical output such as that shown in Fig. 2 is typical of such a sensitivity analysis. The smaller the angle of the line to the x axis the greater the sensitivity of the estimate to this particular parameter change.
Whilst computers take much of the hard work out of discounted cash flow and associated sensitivity analysis it must be borne in mind that cash forecasts are undoubtedly open to wide margins of error. Care must therefore be taken, especially over the early years of the project, in estimating such cash flows as accurately as possible. In addition a whole host of economic and political factors must also be taken into account if the analysis is to be meaningful.
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FIG. 2 Graphical sensitivity analysis results for a typical transmission
project.
% Variation from basic estimate
% Change in NPV at 10% 20 _20 40 60 _40 _60 Generation costs Basic case NPV = £10 million, say Delay during construction Change in capital costs Change in operating costs New technology
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2.3 Economic Assessment
2.3.1 Principles
The economic appraisal of electrical transmission and distribution schemes is generally a three stage process. Firstly, the cost of the scheme has to be assessed _ taking account not just of the initial capital cost but also of the costs likely to be incurred over the life of the project (the so-called 'whole life cost'). Various technically viable schemes are therefore considered and costed.
Secondly, an estimation of the financial and economic benefits as revenues plus cost savings is made. Thirdly, a comparison between the discounted benefits and costs is computed using discounted cash flow techniques.
The minimum amount of benefit relating to an electrification scheme can be measured by the amount of revenue collected from the estimated future potential consumers. In normal cases the benefits are in excess of this basic amount paid for the electricity because:
_ electricity is cheaper than alternative sources of energy;
_ electricity is of superior quality to the alternatives;
_ electricity makes possible new and extra activities.
In such cases the gross benefit equals the amount paid by the consumers for the electricity plus some 'surplus benefit'. Surplus benefit consists of one or more of the following:
_ cost savings related to the alternative;
_ the value of difference in quality;
_ the value of any extra output or activity generated by lower costs and/or a change in quality.
In developing countries the willingness to pay for the incremental electricity sales may be estimated in terms of the costs which the consumers would have had to bear in order to meet their energy requirements in the absence of the proposed project. It may also be possible to quantify other benefits in money terms. The estimation of avoided costs yields a minimum measure of 'consumer surplus'. Often the benefits outweigh the price considerably. That is, 'consumer surplus' is high.
Actual and forecast consumption levels and consumer numbers are derived from field surveys and may be broken down into customer groups (low voltage domestic, high voltage domestic, low voltage commercial, high voltage commercial, low voltage industrial, high and extra high voltage industrial, institutional, rural, etc.) all having possible different tariff rates.
2.3.2 Cost-Benefit Analysis
When consumers purchase electricity from the National Grid, it is apparent that they do so because the benefits to them outweigh the price they have to pay for the service. The benefits can be any combination of the following:
_ Resource saving _
The price of the supply company's service is typically much cheaper than that can be obtained from a substitute or from a private source of supply. Public electricity is cheaper than electricity from small individual diesel fuel powered generators (or from wind or solar, without a basic subsidy) for all but low levels of demand in remote areas.
_ Superior quality energy supplies _
Electric lighting is valued more highly by 'households' or consumers because it is of a higher quality than kerosene-fuelled substitutes.
_ Extra output _
This may be produced on account of the reduced prices of the service (relative to substitutes), or by extra quality, or both. More lighting, more motive power, and more business activity may all be induced by the cheaper or the higher quality service that the transmission or distribution project offers.
The benefits estimation analysis methodology is concerned with the calculation of this incremental consumers' surplus.
FIG. 3 Demand curve for electrical power as an example of consumer
surplus.
Willingness-to-pay benefits can be estimated by placing forecast electricity consumption into two categories. Firstly, that electricity consumption which is considered to have been a substitute for consumption of an alternative source of energy (a diverted market); secondly that consumption which would not have occurred in the absence of the project (a generated market).
Willingness to pay in the diverted market for each consumer group can be estimated with reference to the cost of the total displaced alternative source of energy. An estimate of the willingness to pay in the generated market is not so straightforward. Benefits are therefore defined as the avoided initial and recurring costs of the alternatives to incremental Grid Supply Company electricity. The method does not necessarily make specific allowance for incremental consumer surplus on the generated market as distinct from the diverted market. The avoided costs can be suitably adjusted to reflect the declining valuation of energy inputs with increasing consumption that would apply to the generated market.
FIG. 3 outlines the methodology on a price/quantity demand graph.
Line DQ0_DP0 is to be interpreted as showing the maximum amount that a consumer would be willing to pay for each successive unit of electricity in a particular period. The total willingness to pay for the quantity Q1 is the area under the DQ0_DP0 line 0_Q1_C_DQ0. With the price P1 the amount the consumer is required to pay is 0_Q1_C_P1. The difference between what the consumer is prepared to pay and that which is actually paid is often referred to as the 'consumer surplus', area P1_C_DQ0.
Electricity from the Grid as a result of a transmission and distribution project may be seen as a substitute for the use of, say, kerosene for lighting or for diesel, used for motive power directly or for diesel generation.
In each case the 'consumer surplus' can be measured by the net difference in costs between using electricity from the Grid or a substitute. Again, using Fig. 3,letP1 be the unit price of electricity from a diesel genera tor and P2 be the electricity supply company tariff for all the incremental electricity, and quantity Q2 be assumed to be supplied as a result of the project under consideration. Given that the quantity Q2 is supplied at the price P2 the change in 'consumer surplus' as opposed to that existing, if alternative energy supplies were to be used, is measured by the area P2_B_C_P1. A minimum measure of this incremental 'surplus' is given bytheareaP2_A_C_P1, which represents the cost saving to those energy users in the diverted market. The cost savings can be used to obtain an approximate measure of any incremental 'surplus' for all these consumers for whom substitutes for the use of electricity from the Grid system are available.
The availability of lower cost electricity as a result of the project and the tariff structure may lead to an increase in planned output levels by new businesses, which would have been unprofitable using the substitute forms of energy. A separate estimation of 'surplus' for such a generated market may also be attempted in a full economic study.
2.3.3 The Difficulties
The practical difficulty of converting perceived benefits into money terms that may then be used in a financial and economic analysis is open to priori ties based upon political opinions. A famous early cost benefit analysis in the late 1960s for the assessment of the Victoria Underground Metro line in London used such factors as:
_ waiting time for people held up in traffic jams in their cars if the line was not built;
_ pollution levels due to high traffic in London without the line;
_ stress levels on health of people being delayed in traffic jams.
Obviously such assessments will have a degree of subjectivity. The very important advantage of such cost benefit analysis techniques is to provide a level playing field for the comparative assessment of a variety of similar projects such that the 'best' may be selected. Such analysis has become an essential part of the project selection process demanded by the large aid agencies.
Consider as an example of the difficulties, a rural electrification project in a developing country where the options include:
_ a small hydro electrification scheme and associated distribution from the generators to the load centers;
_ a diesel generation scheme.
To an experienced engineer it is well known that the life of diesel generators in such applications is very short. Even if maintenance is good often foreign exchange constraints make the availability of spare parts very difficult.
In comparison hydro schemes have extremely good records of reliability, long life and once built do not drain the foreign exchange reserves of the country on possible costly fuel imports. A hydro scheme is capital intensive and, since monies in the early stages of a project are emphasized in discounted cash flow analysis techniques, often small hydro schemes are rejected. In fact they are often able to provide a much better service to the community.
3 FINANCING
3.1 Responsibilities for Funding
Borrowing money on the open market is expensive and so both client and contractor should attempt to keep these costs to a minimum. For example it may well be possible for a large and stable electricity supply company to arrange and pay for insurance costs associated with a particular construction contract because they are able to obtain preferential rates. If the client leaves all such costs to be borne by the contractor then they will only appear in the contractor's tender sum with a suitable mark-up. Therefore the client could well end up paying more for the project overall in the long run without this more mature approach to contract financing.
The principle to be adopted in a large construction contract between client and contractor is that the individual contract costs must be borne by the side best able to bear them if the costs are to be kept to a minimum. Such cost allocation must include risk costs; poor risk management is one of the major factors in total project cost, and a sensible contract will attempt to ensure that risk responsibility lies where it is best managed.
3.2 Cash Flow
Since a contractor starved of cash cannot function, the following factors are important:
1. Sufficient advance payments to the contractor should be considered. The purpose of such payments is to cover contract 'front end' expenditure such as mobilization, early engineering work, payments to sub-contractors, commission and insurances. Typically such advances will be of the order of 10% of the contract value.
2. Progress payments to the main contractor on a regular basis related to the value of work actually achieved. These should not normally be related to payments made by the main contractor to the sub-contractors. An independent valuation by respectable, professional and independent quantity surveyors or consulting engineers on behalf of the client assists in reducing client/contractor disputes.
3. Progress payments linked to the timely completion of specific defined parts of the works or milestones. These must be capable of easy definition and measurement.
4. Retentions kept by the client from interim progress payments during the course of the contract. The purpose of these is to act as an incentive for the contractor to finish the works.
5. Insurance bonds or bank guarantees to be provided by the contractor and held by an independent bank as surety that the contractor will complete the works. These are often capable of being redeemed by the client 'on first demand'. Following some abuse of this terminology in the 1970s such wording should be avoided if at all possible by the contractor before a contract is signed. A better wording might be, 'on first written demand by two authorized and agreed client signatories'. This makes snap decisions by the client, which may not be strictly in accordance with the con tract, more difficult, and gives a little more time for reflection. Such retentions are typically 5_10% of the contract value.
6. Payment documentation should be simplified as much as possible in order to avoid misunderstandings and non-payment by the client. Further the contractor will attempt to ensure that one payment is not conditional upon another unrelated event associated with the contract works.
3.3 Sources of Finance
Sources of finance for a project may be internal to the client and taken out of investment capital provisions or reserves held in the accounts. Client support for the project may also arise from tax incentives or local currency loans.
External sources of funds include:
_ Export credits from the contractor's or major transmission and distribution plant manufacturer's countries.
_ Commercial loans, often linked to export credits.
_ Development aid in the case of developing countries (Asian Development Bank, European Development Bank, World Bank, etc.).
_ Provision of future cash flows from future electricity sales associated with the project or counter-trade (barter) deals are also considered. Such cash flows may be used to justify the capital raised specifically for the project _ see also Section 22.3.6.
3.4 Export Credit Agencies
3.4.1 Introduction
Export credit agencies are generally set up or sponsored by their relevant government with the primary function of encouraging the export of manufactured goods. The export credit agencies offer guarantees for loan liabilities, preferential insurance rates to cover commercial and political risks, fixed interest rates for certain currencies below those available on the open market, inflation and exchange rate fluctuation protection.
The various criteria which need to be satisfied in order to obtain support from such agencies, therefore, include:
_ majority of equipment and services to originate from the agency country;
_ financial soundness and reputation of contracting organization;
_ financial soundness and reputation of client organization;
_ the category status (based in part upon the Gross National Product (GNP) per capita, inflation, stability, etc.) of the client's country and classified relatively rich, middle income, and relatively poor.
There are a number of alternative financing structures used by export credit agencies to support the payment terms associated with an export contract.
3.4.2 Supplier Credits
The contractor or manufacturer takes the lead to arrange for payments, administration and funding to support costs until monies are received from the client or purchaser as the contract proceeds (see Fig. 4a).
3.4.3 Buyer Credits
The client or purchaser arranges a loan agreement with a bank. The contractor then receives these funds as the contract proceeds. This is normally the most appropriate finance structure for major transmission and distribution lump sum turnkey projects involving interim or progress payments (see Fig. 4b).
An advantage to the contractor over supplier credit is that the funding arrangements do not appear on the contractor's balance sheet accounts.
3.5 Funding Risk Reduction
Obviously overseas transmission and distribution projects involve additional financial risks compared to home-based construction works. However, even home projects which involve a high level of imported materials will involve financial risk associated with foreign exchange fluctuations. These finance risks may be reduced under buyer or supplier credit schemes by placing the funding work in the hands of experts. A confirming house may, for example, act as a 'go between' client or contractor and the banks, credit agencies, insurance companies, etc. They are able to advise on the best funding arrangements to suit a particular project and are often able to speed up the financing process. However, all such precautions cost money to arrange and execute thereby reducing profit margins. The risks and costs must be care fully weighed up before commitment. FIG. 5 shows the application of such a simple analysis which tends to highlight areas often overlooked when judging risk on purely money terms. For example client/contractor organization structures, planning systems (PERT analysis _ program evaluation and review techniques using logical program networks and critical path analysis), sophisticated insurance cover, etc. are also important.
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FIG. 4 (a) Supplier credit; (b) buyer credit.
Client Contractor (or supplier) Lending bank Export credit agency Guarantees Insurances Finance Supply or construction contract (a) Client (or buyer) Contractor Lending bank Export credit agency Guarantees Insurances Finance Supply or construction contract Loan agreement (b)
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FIG. 5 Financial risk minimization.
Avoidable risk? Insurable risk?
Yes Yes No Yes No No
Where economic, make alterations to conditions of contract Arrange appropriate insurances Make necessary arrangements (exchange rate, inflation, etc.) to control and monitor Controllable risk? Consider ways to fund residual risk
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3.6 Use of Private Finance
There is an increasing trend for public authorities around the world to make use of private capital to fund major utility or infrastructural projects. An entrepreneur or, more typically a consortium of firms (which may include con tractors, consultants, manufacturers and sometimes banks) will raise the capital to undertake the project, will employ that money to execute the project and will be the managers of the assets resulting for an agreed period, known as the 'concession period'. The concession period may be as long as 30 years, during which time they receive income, either in the form of 'rental' from the client body or by having rights (a 'concession') to receive payment direct from the end users (e.g. the electricity network operators using a new transmission sys tem link). The consortium will normally be responsible for maintenance of the asset during this period, and will hand the asset over to the utility or government department concerned at the end of the concession.
The advantage of this approach to the client is that the money raised to buy and install the asset does not appear as a debt on the public authority's balance sheets, thus avoiding any effect on the financial ratios of the body concerned. The corresponding disadvantage may be that the cost of this capital, which is eventually paid for by the client through the rental or the transferred rights to income, is probably higher than the cost of capital raised by the public body itself. This will be the case if the financial markets see the risks of that public body reneging on its debts as being less than the risk of lending money to the concessionaire.
It will also be the case that the risks of construction cost over-run and higher than planned operating costs are transferred to the concessionaire.
This should result in reduced costs overall if the bodies chosen by the concessionaire to construct and operate the asset are better positionable to man age these risks than the client.
For the consortium comprising the concessionaire this approach offers the opportunity to obtain improved return on their capital by building and operating the concession efficiently. There is a risk of a poor return, or even the loss of their capital, if the project costs more to build or to operate than estimated, and the original bid for the private finance project will have included some financial quantification of this risk.
A variant of the private finance project is a joint funding arrangement whereby the client provides just a part of the total capital, and the concessionaire provides the balance. The share of risks and responsibilities will then depend upon the negotiated arrangement in each case.
4 PROJECT PHASES
4.1 The Project Life Cycle
A project is the process of creating a specific result. Infrastructure transmission and distribution development projects all tend to follow the same general phases as shown in Fig. 6.
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FIG. 6 Project phases.
Business Decisions Board policy formulation, management planning, and operation Project Proposals Concept Initial strategic planning
------------------ Definition
Initial engineering
----------------- Design
Procurement
----------------- Development
Construction
----------------------- Application
Commissioning
------------------- Post completion
Operations
---------------- Time through the project
Project Go-ahead
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The concept and planning stages will require the type of financial and economic evaluation together with finance resourcing as detailed in Sections 22.2 and 22.3. In a 'fast track' project, where the client requires very fast completion times, considerable overlapping of the different project phases occurs. This is not to be recommended unless the particular project work is well understood and has been completed before. Such 'fast track' project work has a history of escalating prices and in some cases much longer construction periods than originally envisaged. The most important point is to ensure clear definition of the exact project requirements. Although the different project phases cannot usually be compartmentalized into clearly defined boxes with rigid start and end dates, rules should be set up such that sufficient definition is available before commencing each project phase. For example so many percent of steel work design complete before ordering, so many percent orders placed before delivery to site, so much paving and access road laid before commencement of steelwork erection (to avoid the site becoming a quagmire in Winter, etc). Only in this way will rework costs be kept under control in a 'fast track' or indeed a more traditional project.
It is also important to understand the relative magnitudes of the financial commitments involved during the different life cycle project phases.
Although planning applications and studies take time the actual expenditure during the concept and definition phases is relatively small. Expenditure will increase as the engineering design phase gets underway and will continue to increase very steeply during the construction period. Such expenditure and progress through a project tends to follow an 'S-curve' shape as shown in Fig. 7. If a project has to be abandoned then it is obviously necessary to make such decisions as early as possible in order to avoid abortive expenditure.
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FIG. 7 Typical project 'S-curve'
% Completion or % expenditure Time through the project Engineering Procurement Construction Commissioning Operations.
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FIG. 8 Typical project cash flow.
Revenue minus costs and tax; Expenditure on fixed assets after grants; Expenditure on working capital; Cash flow (in million)
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FIG. 9 Relative uncertainty of ultimate time and cost by life cycle
phase.
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4.2 Cash Flow
Typical project cash flows resulting from a substation construction project might be as shown in Fig. 8, where the revenue from the additional customers is fully attributed to the project itself. Such projections are used in the initial financial assessment of the project and should be regularly updated as the project proceeds. There is always the necessity to appreciate the relative uncertainty of the ultimate time duration and cost during the different project life cycle phases (see Fig. 9).
4.3 Bonds
4.3.1 General
The contractor may be required to provide bank bonds as part of a construction contract. The bonds are paid for by the contractor as a small percentage of their full value. Such bonds are usually held by the banks and may be called upon by the client to be converted into cash payments if the contractor fails to per form in accordance with the contract. The bank and the contractor arrange a back-to-back agreement such that if such bonds are called for payment by the client then the contractor either directly, or using insurances, pays the bank the money owing. An explanation of the effect of bond guarantees on cash flows during a construction contract based upon the International FIDIC Terms and Conditions of Contract is given in Fig. 10.
4.3.2 Tender Bonds
Initially a bond may be required from the contractor by the client as early as the tender stage before the final contractor has even been chosen. 'Tender Bonds' are introduced in order to discourage a large number of contractors from tendering for the works without any real intention of accepting the job.
Such an occurrence would result in abortive tender evaluation by the client and possible costly retendering. Tender bonds may not be returnable to tenderers by the client after the tender process and they therefore act as an insurance to the client that only serious contenders apply for the work.
4.3.3 Performance Bonds
During the course of the construction contract, the client may wish the con tractor to take out a 'Performance Bond'. This acts as a guarantee of due performance by the contractor and may be typically 10% of the total contract value.
4.3.4 Maintenance Bonds
After construction, the contractor usually has a continuing obligation to the client for the repair of faults in the works due to the contractor's bad workman ship or materials employed. This is known as the 'maintenance period' and is about 1 or 2 years for mechanical and electrical projects. The client may with hold monies from the contractor to ensure that he will return to repair such defects during this maintenance period. The contractor may offer the client a 'maintenance period bond' in return for 100% cash payment upon handing over the completed works to the client. In this way the contractor obtains full monies but guarantees, against the possible encashment of the 'maintenance bond', a continuing obligation during the maintenance period.
4.4 Advance Payments and Retentions
The client may advance to the contractor say 10% of the contract value, upon signing the agreement between client and contractor to carry out the works.
This may be tied to receipt of the contractor's detailed program for completion of the works or similar requirements. The idea is to assist the contractor during the early stages of the contract. Presumably the client has already budgeted for such provisions and is therefore best able to carry this burden, which is intended to keep the contractor's prices down.
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FIG. 10 Finance payments under FIDIC construction contract.
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During the course of the contract retentions are made on progress payments to the contractor by the client. For example if a 30% progress payment is due to the contractor upon certified completion of 30% of the contract works then the client may deduct a 10% retention to recover in stages the originally made 10% advance payment. In addition retentions, say a further 5%, may be held by the client to cover the contractor's maintenance period obligations. An example of the effect of such advance payments and retentions upon the contractor's project cash flow is given in Fig. 10.
4.5 Insurances
A wide variety of insurances are required to be taken out by client and the contractor both under national legal requirements (generally covering safety) and the specific requirements of the particular construction contract being employed. These include contractors all risks (CAR) insurance. In particular, insurances to cover damages to equipment from the time it is being manufactured, through transportation to site, and during erection and commissioning on site are necessary. The cost of such equipment, if damaged whilst in the care of the contractor, may be more than he could be capable of covering and lack of speedy replacements could put the project in jeopardy.
4.6 Project Closeout
The possible long 'tail' on the project life cycle S-curve at the end of the project requires careful management. Often certain key items, which may not seem significant to the contractor, cause delay in the receipt of final payments. For example items such as correctly delivered final commissioning test records, operations and maintenance manuals or as-built drawings are often all tied into release of payments, even though the works themselves have been handed over to the client.