Thus, the additional ﬁnancial liability that Sponsors incur may become very
signiﬁcant in the absence of an EPC Contract.
Furthermore, the deﬁnition of “completion” in such cases has to be carefully
considered. It usually involves not just physical completion of the project, but a
demonstrated ability to operate as projected over a sustained period of time.
§8.6 ENVIRONMENTAL RISKS
The environmental aspects of a project may raise various contractual, legal,
and wider political risks. The possibility of preexisting pollution at the site will be
an issue under the EPC Contract (cf. §8.5.4), and the EPC Contractor is of course
required to construct the project to meet environmental standards on emissions,
etc. (cf. §7.1.8).
Even if the Project Company has obtained the necessary Permits to construct
and operate the project, it may still remain at risk from changes in law relating to
environmental aspects of the project (e.g., emissions) that require extra capital ex-
penditure (cf. §10.6).
Most public-sector lenders, such as the World Bank and European Investment
Bank, have their own environmental standards mandated by their members (i.e.,
state shareholders) and may require these to apply to projects even if local law
does not require this. In the worst case this could put the Project Company into de-
fault under the ﬁnancing if it violates these standards, even though it is not break-
ing the law in the Host Country.
Even if the Project Company is acting within the local law, it may still be at risk
on wider political grounds. Public opposition to the project may cause the gov-
ernment to reconsider its obligations under a Project Agreement or Government
Support Agreement. Similarly, the lenders themselves may ﬁnd themselves under
attack in their home countries for supporting a project that is perceived to be en-
vironmentally damaging; some lenders apply general environmental requirements
to all their loans.
Sponsors and lenders cannot rely only on keeping within the law of the Host
Country; they need to consider whether any environmental aspects of the project
leave them at risk of opposition to construction or operation of the project indi-
rectly discouraging lenders from getting involved with it. An EIA (cf. §7.4.1) is
an important part of the due diligence that should reduce any lender concerns.
§8.7 OPERATING RISKS
Once the project has been completed and is demonstrated to be operating to
speciﬁcation, a new risk phase begins, that of long-term operation. Even if the
Project Company has hedged many of its risks through a Project Agreement, some
§8.7 Operating Risks 155
level of operating risk is likely to be left with the Project Company, and therefore
this aspect of the risks is closely reviewed by lenders.
The key operating risks include:
• Technology (cf. §8.7.1)
• General operation of the project (cf. §8.7.2)
• Operating cost overruns (cf. §8.7.3)
• Availability (cf. §8.7.4)
• Maintenance (cf. §8.7.5)
• Performance degradation (cf. §8.7.6)
New technology. Even if the project passes its performance tests (cf. §7.1.6),
there may still be concern about the long term risks if it involves new
Lenders are always reluctant to lend against a project that is using new and
untried technology, whose performance cannot be checked against existing
references. The problem is that the new technology risk is unquantiﬁable and
cannot be covered by performance LDs from the EPC Contractor because
they do not cover a future deterioration in performance. In this context, new
technology has a wide deﬁnition: it includes major improvements to existing
technology, for example, a gas turbine for a power plant that is supposed to
deliver signiﬁcantly greater efﬁciency than the manufacturer’s current
model. (It is also worth noting that insurance companies charge higher pre-
miums for new technology plants because of the increased uncertainty in
If new technology is being used the operating risk can be mitigated in var-
• The EPC Contractor may give a long-term performance guarantee, rather
than the warranties normally provided, which are limited both in amount
and to a term of 2 –3 years. The problem with this approach, however,
is deciding whether a problem with the plant in several years’ time is
caused by a defect in design or construction (the EPC Contractor’s fault)
or in the way it has been operated (the Project Company’s fault).
• The Sponsors may provide a long-term performance guarantee, perhaps
counterguaranteed by the EPC Contractor or the manufacturer of the plant
In summary, however, project ﬁnance is more suitable for established
Obsolescence. The converse of this is the risk that the technology used in the
project may become obsolescent and thus uncompetitive in the market in
156 Chapter 8 Commercial Risks