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Erasmus University Rotterdam

MSc in Maritime Economics and Logistics 2004/2005

Risk Analysis in Port Finance


By

Vaibhav Desai

Copyright MSc Maritime Economics & Logistics

Acknowledgements
Even if a thesis is the result of the primary effort of author, it is really impossible to complete without intellectual and moral contribution of a large group of people. I am truly thankful to all the people at ECORYS, with whom I spent quality time during which I worked on my thesis. I am especially grateful to Edward Wentink for his invaluable contribution, cooperation and suggestion during the whole process of the thesis. Despite his busy schedule, he spent time and attention to read and comment the every chapter in detail. A special thank goes to Hein Gietema and Marcel Vd Broek for giving me opportunity to do internship in the ECORYS.I would like to thank to Nienke, Diederik, Maurice, Elvira, Patricia, Herman and Jurjen for some of the pleasure moments we spent at the office. I am very pleased to acknowledge the valuable comments, corrections and suggestions of my supervisor Frans Waals. I am also thankful to Michele Acciaro for providing me some valuable thinking at the beginning of the thesis. I would also like to thank Hitendra Solanki, Gujarat Maritime Board, Gujarat, India, for his valuable suggestions and reviewing the thesis. Finally, a deep expression of gratitude is addressed to my brother Bhavesh Patel, without his unconditional support and encouragement for the entire year I would have never been able to achieve this result.

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Abstract
During the last few years, port industry has endured a period of radical changes largely due to a growing importance of the physical integration of transport chain which has brought about uncertainty making port planning extremely difficult. In the present era of integrated approach, port must make large investment in port facilities for being successful link of entire chain. Having considered this increasingly global nature of the logistics approach and requirement of large investment and efficient port management, an understanding of risk analysis in port finance is extremely important. One of the most complicated aspects in the port sector is properly designing a risk management system. This thesis explores how risk analysis process is implemented in port sector with particular references to major risks, risk factors, and risk allocation and mitigation approach using different port models, and case studies in real practice. Usually port sector faces the same risks as other sectors face. However, particular attention has been paid to construction, social, financial, commercial, country, monetary and environmental risks in the thesis. They are considered as the major risks involved in the port finance. The responsible risk factors under the four port governance models are different from each other based on the allocation of rights and responsibilities between parties involved in the port activities. In the service and tool port models, most of the risks are allocated to public authorities i.e. governments, port a uthority, and other public entities, while in the landlord port model, commercial and operating risks are entirely allocated to private sector and remaining risks are shared among parties. In the private port model, private companies are responsible for all risks. Six case studies have been considered to analyze how risks are allocated and managed in the real practice. The findings of this analysis show that risks are better allocated and managed under the landlord port model in comparing other port models. The port of Latakia operated under the service port model becomes the less efficient due to a poor risk management approach of the government. The movement of the port of Shahid Rajaie from the tool to landlord port model provides the better understanding of the need of private sector involvement for better risk allocation and mitigation. Under the landlord port model, the port of the Maputo, the port of Long Beach and the port of Xiamen provide the best example of the risk allocation and management. The risk management strategy applied in the port of the Felixstowe proves that even risks are allocated to single party, risks can be managed efficiently. Based on the theoretical chapters and case studies, author has drawn the risk analysis framework that should be implemented by port authority and private sector for desired outcomes.

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List of Tables
Table 1: Responsible factors of economical risk ......................................................... 15 Table 2: Classification of port assets........................................................................... 20 Table 3: Strengths and weaknesses of the service port model.................................... 21 Table 4: Distribution of responsibilities of port activities in the service port model.... 22 Table 5: Strengths and weaknesses of the tool port model ......................................... 23 Table 6: Distribution of responsibilities of port activities in the tool port model ......... 24 Table 7: Strengths and weaknesses of the landlord port model.................................. 26 Table 8: Distribution of responsibilities of port activities in the landlord port model.. 32 Table 9 : Strengths and weaknesses of the private port model ................................... 33 Table 10: Distribution of responsibilities of port activities in the private port model... 34 Table 11: Common risk mitigation practice in the port sector ..................................... 39 Table 12: Risk factors in the service port model.......................................................... 43 Table 13: Distribution of responsibities of port activities in the port of Latakia........... 45 Table 14: Risk allocation & mitigation in the port of Latakia........................................ 45 Table 15: Risk factors in the tool port model ............................................................... 50 Table 16: Distribution of responsibility of port activities in the port of Shahid Rajaie . 52 Table 17: Risk allocation and mitigation in the port of Shahid Rajaie.......................... 53 Table 18: Risk factors in the landlord port model........................................................ 59 Table 19: Distribution of responsibilities of port activities in the port of Maputo ........ 62 Table 20: Risk allocation and mitigation in the port of Maputo.................................... 63 Table 21: Distribution of responsibilities of port activities in the port of Long Beach . 68 Table 22: Risk allocation and mitigation in the port of Long Beach............................. 69 Table 23: Distribution of responsibilities of port activities in the port of Xiamen........ 74 Table 24: Risk allocation and mitigation in the port of Xieman.................................... 75 Table 25: Risk factors in the private port model .......................................................... 79 Table 26: Distribution of responsibilities of port activities in the port of Felixstowe ... 81 Table 27: Risk allocation and mitigation in the port of Felixstowe............................... 82 Table 28: Impact and Likelihood of Risk ...................................................................... 87 Table 29: Risk allocation table..................................................................................... 89 Table 30: Risk mitigation approaches.......................................................................... 91

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List of Figures
Figure 1: The Thesis Structure ......................................................................................4 Figure 2: Major risks in port investment and management............................................7 Figure 3: Primary factors for a country risk ................................................................. 13 Figure 4: Swap contract............................................................................................... 16 Figure 5: Classification of port activities..................................................................... 19 Figure 6: Comparison of lease systems....................................................................... 28 Figure 7: Risk allocation .............................................................................................. 37 Figure 8: The port of Latakia........................................................................................ 44 Figure 9: The port of Shahid Rajaie ............................................................................. 51 Figure 10: The port of Maputo...................................................................................... 60 Figure 11: Shareholders of the MPDC.......................................................................... 61 Figure 12: The N4 Highway linking Johannesburg and Maputo................................... 61 Figure 13: The port of Long Beach .............................................................................. 67 Figure 14: Throughput of terminal T, the port of Long Beach...................................... 72 Figure 15: The port of Xiamen...................................................................................... 73 Figure 16: Throughput of XICT .................................................................................... 77 Figure 17: The port of Felixstowe ................................................................................ 80 Figure 18: Risk identification chart .............................................................................. 86 Figure 19: Risk allocation chart ................................................................................... 88

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List of Abbreviations
ADB BOO BOOT BOT BROT BTO CFM Asian Development Bank Build Own Operate Build Own Operate Transfer Build Operate Transfer Build Rehabilitate Operate Transfer Build Transfer Operate Caminhos de Ferro de Mocambique

COFACE Compagnie Francaise dAssurance du Commerce Exterieur EOT FDI FTZ HPH HWL IFC IMO IPO JVA LBHC LGPC MIGA MIS MPDC PFL PNYNJ PSO ROT SIDA TTI TRAC XICT XPG Equip Operate Transfer Foreign Direct Investment Free Trade Zone Hutchinson Port Holdings Hutchison Whampoa Limited International Finance Corporation International Maritime Organization Initial Public Offer Joint Venture Agreement Long Beach Board of Harbor Commissioners Latakia General Port Company Multilateral Investment Guarantee Agency Management Information System Maputo Port Development Company Port of Felixstowe Port of New York and New Jersey Port & Shipping Organization of Iran Rehabilitate Operate Transfer Sweden International Development Government Agency Total Terminals International Trans African Concessions (Pt) Ltd Xiamen International Container Terminal Xiamen Port Group Company

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Table of Contents
Acknowledgements .................................................................................................... I Abstract....................................................................................................................... II List of Tables............................................................................................................. III List of Figures........................................................................................................... IV List of Abbreviations................................................................................................. V Table of Contents...................................................................................................... VI 1 Introduction ........................................................................................................ 1

1.1 1.2 1.3 1.4


2

The Background of the thesis ....................................................................... 1 The Objectives of the thesis ......................................................................... 2 Methodology ................................................................................................ 3 The structure of the thesis ............................................................................ 4

Risk in Port Finance .......................................................................................... 6

2.1 Introduction.................................................................................................. 6 2.2 The Concept of Risk .................................................................................... 6 2.3 Risks involved in port investment and management ................................... 7 2.3.1 Construction risk .................................................................................. 8 2.3.2 Social risk............................................................................................. 8 2.3.3 Financial risk........................................................................................ 9 2.3.4 Commercial risk ................................................................................. 10 2.3.5 Country risk........................................................................................ 13 2.3.6 Monetary risk .................................................................................... 16 2.3.7 Operating risk..................................................................................... 17 2.3.8 Environmental risk ............................................................................. 17
3 The Port Governance Structure ..................................................................... 18

3.1 Introduction................................................................................................ 18 3.2 Port Governance Models............................................................................ 18 3.2.1 Service port model ............................................................................. 21 3.2.2 Tool port model.................................................................................. 23 3.2.3 Landlord port model........................................................................... 25 3.2.4 Private port model.............................................................................. 33
4 Risk and Port Activities................................................................................... 35

4.1 Introduction................................................................................................ 35 4.2 Risk and Port activities .............................................................................. 35 4.3 Risk Management ...................................................................................... 36 4.3.1 Risk Allocation .................................................................................. 37 4.3.2 Risk Mitigation .................................................................................. 38
5 Risk Analysis in the Service port model....................................................... 40

5.1 Introduction................................................................................................ 40 5.2 Risk and Risk factors in the service port model ........................................ 40 5.3 Case Study- The port of Latakia, Syria....................................................... 44 5.3.1 Geographical location........................................................................ 44 5.3.2 Port governance structure................................................................... 44 5.3.3 Risk Management .............................................................................. 45
6 Risk Analysis in the Tool port model............................................................ 48

6.1 6.2

Introduction................................................................................................ 48 Risk and Risk factors in the tool port model.............................................. 48

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6.3 Case study- The port of Shahid Rajaie, Iran.............................................. 51 6.3.1 Geographical location........................................................................ 51 6.3.2 Port governance structures................................................................. 51 6.3.3 Risk Management .............................................................................. 53 6.3.4 Why port moves from tool to landlord port model? .......................... 55
7 Risk Analysis in the Landlord port model.................................................... 57

7.1 Introduction................................................................................................ 57 7.2 Risk and risk factors in the landlord port model........................................ 57 7.3 Case study-The port of Maputo, Mozambique .......................................... 60 7.3.1 Geographical location........................................................................ 60 7.3.2 Port governance structure................................................................... 60 7.3.3 Risk Management .............................................................................. 62 7.4 Case Study- The port of Long Beach, USA................................................ 67 7.4.1 Geographical location........................................................................ 67 7.4.2 Port governance structure................................................................... 67 7.4.3 Risk Management .............................................................................. 69 7.5 Case Study- The port of Xiamen, China ..................................................... 73 7.5.1 Geographical location........................................................................ 73 7.5.2 Port governance structure................................................................... 73 7.5.3 Risk Management .............................................................................. 75
8 Risk Analysis in the Private port model........................................................ 78

8.1 Introduction................................................................................................ 78 8.2 Risk and risk factors in the private port model.......................................... 78 8.3 Case study-The port of Felixstowe, UK .................................................... 80 8.3.1 Geographical Location....................................................................... 80 8.3.2 Port governance structure................................................................... 80 8.3.3 Risk management ............................................................................... 82
9 Risk Analysis Framework ............................................................................... 85

9.1 Introduction................................................................................................ 85 9.2 Risk analysis framework ............................................................................ 85 9.2.1 Stage 1- Risk Identification................................................................ 85 9.2.2 Stage 2- Risk Allocation.................................................................... 88 9.2.3 Stage 3- Risk Mitigation.................................................................... 90
10 Conclusion and Further Research................................................................. 93

10.1 10.2

Conclusion ................................................................................................. 93 Further research.......................................................................................... 94

Bibliography ............................................................................................................. 96 Appendix................................................................................................................... 98

Appendix 1: Risk Identification Checklist Table ................................................... 98

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1 1.1

Introduction The Background of the thesis

We are witnessing an increasing trend towards the private sector participation in the public service sectors such as highway, railway, airport, telecommunication, seaport, water and power sectors in the developed as well as developing countries. However this new trend has especially been increased remarkably in the port sector aimed at introducing private sector in port operation and management previously under the control of central, state or public entity. Particularly, globalization of the production, tremendous gain in productivity of ocean transport, innovative systems and new technology are responsible factors for such revolution. Before 3 decades ports were generally under the control of central or state -4 government. Competition between ports was minimal therefore port-related costs were relatively high in comparison with ocean transport and inland transport (World Bank, 2001). Today, Globalization of the production and increasing international trade have made world economies closely interrelated. Vertical specialization1 with significant impact on global supply chain has forced to all players to compete with another for global market. This new tendency towards globalization has brought about a new revolution in entire transport industry. It has required the changes in international transport system and reshaped the entire transport industry from segmented modal approach to integrated transport approach placing shipping and port services at the forefront of the new transport logistics chain to meet the needs of customers. Such trend is continuously and increasingly pressure on the ports located worldwide to acclimatize their role and function in more demanding and competitive environment. A number of above mentioned external developments are creating such circumstances under which port industry becomes more and more vulnerable to increasing changes in the land as well as sea side that reduces ports abilities to secure even their own cargo traffic and markets share. To survive in the changing operational environment, port industry has to make a large scale of investment in expensive infrastructures and superstructures and, developing ever large terminal sites. In developed and developing countries, government and port authority failed to respond adequately to this n movement and demand and thus many ports ew became bottleneck to efficient distribution chain. This has consequently opened the market f r private sector involvement in port operation and management. As a o result, whole port industry has been changed significantly. A new trend of private sector participation has introduced different governance structures in port sector around the world. Four port governance models have been distinguished on the basis of the degree of private sector participation, the role of public and port sector, funding method, and operation and management strategy. Particularly, under the landlord port model,
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Vertical specialization refers the situation under which a country produces final product using intermediate raw material imported from different countries and later final product is exported in other countries. (World Bank Port Reform Toolkit, 2001)

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private sector has to make large investment in infrastructure, superstructures and equipments required to provide appropriate services to current demand. Projects of this type completely set on a financing basis that generates significant risks for the all parties i.e. private operator, financial Institutions, and port authority. Therefore, the careful risk analysis should be implemented to make success the whole port project. In the thesis particular attention has been paid to define more precisely the major risks, responsible risk factors in each port model, risk allocation and mitigation of risks in the real practices. Considering theoretical chapters, and practical case studies, risk analysis framework has been designed for port project.

1.2

The Objectives of the thesis

The objectives of the thesis can be categorized into following parts: 1. To identify the major risks and risk factors involved in port investment and management Demand for port service is linked to trade-flow to or from the region where port is located, global trade and market, complex legal and regulatory frameworks, increase in size of ship, cargo composition, fierce competition among ports, political instability, hinterland connection etc. Such factors cannot be predicted easily and accurately and their impact on demand for port service also cannot be quantified precisely. They generate significant risks for port investment and management and make return estimate on investment highly uncertain. Risks could adversely affect the port operation and management and they may result in loss of all or part of investment. Therefore, prior to making any decision by government or private operator, risks, source of risks and their impact on investment, port operation and management must be identified. 2. To describe the port governance models, and the relationship between risk and port activities Usually, the structure of each port governance model is different from one other on the basis of the responsibilities and role of public and private sector. Subsequently, if we look carefully at relationship between risk and port activities we can also find out that each risk is related with particular port activities regardless of port models. But risks are different to great extent in each port model in terms of impact of risk, risk allocation between parities involved in port affair, and risk mitigation approach of individual port. 3. To characterize each port model in terms of risks and risk factors, and analyze individual case study to identify how risks are allocated and mitigated under different port models. Port sector is service sector whereby demand is fundamentally derived demand and subject to regional and international factors. Volatility and uncertainties of such factors cause certain risks in port sector. However port is operated under the

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different port model, risks and risk factors are not the similar for every port. Even for ports being operated under the same port model; the probability and impact of risks are considerably different. In individual port practice, public authority or/and private sector consider appropriate risk allocation and mitigation approach considering existing circumstances in port business, while making decision for port management and investment. 4. To build a common risk analysis framework for port projects based on the understanding gained from the theoretical and practical (case studies) aspects of the thesis. It is critically important in port investment and management to scrutinize risks and sources of uncertainties using sound risk analytical tool. In the thesis various ports from different regions of the world are being taken into account to identify factors responsible for risks and understand how risks are allocated between public and private sector. On the basis of such analysis and understanding, a simple risk analysis framework for port projects has been designed. Public Authority or/and private sector should consider such framework before making decision for investment and management in the port sector.

1.3

Methodology

The research methodologies used to accomplish the primary objectives of the thesis are as follow: Literature review: most of the information for the thesis has been collected from comprehensive literatures of port sector and common risk analysis and management practice. Current literatures on the subject consist of journal articles, study materials of MEL, newsletters, and newspapers. A review of literatures aims at obtaining the basic information to analyze the theory aspects of the risk analysis in port finance Case study: Six case studies have been considered to identify the responsible risk factors for major risks under the four port governance models and acquire better understanding of the risk allocation and management by public authority and private sector in real practice. These six case studies include the port of Latakia, Syria under the service port model, the port of Shahid Rajaie, Iran under the tool port model, the port of Maputo, Mozambique under the concession agreement, the port of Long Beach, USA under the lease agreement, the port of Xiamen, China, under the joint venture in the landlord port model, and the port of Felixstowe, UK under the private port model. Specific risk management models, previous experience and knowledge gained from the equity analysis of the different sectors in the stock (financial) market, and understanding gained from the theoretical and practical parts of thesis, have been used to design a risk analysis framework.

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1.4

The structure of the thesis

The structure of the thesis refers to brief description of every chapter of the thesis. It aims at making more explicable how the thesis is going to be written.

Risk Analysis in Port Finance 1. Introduction 2. Risks in Port Finance

3. Port Governance Structures

4. Risk and Port Activities

5. Risk Analysis in Service Port Model

6. Risk Analysis in Tool Port Model

7. Risk Analysis in Landlord Port Model

8. Risk Analysis in Private Port Model

9. Risk Analysis Framework

10. Conclusion

Figure 1: The Thesis Structure

Chapter 1 contains the Introduction, which defines the background, objectives, and methodologies of the thesis. It also illustrates the structure of the thesis with brief description of each chapter. Chapter 2 considers the major risks and risk factors in port investment and management. We identify the areas of uncertainties and obstacles with greatest potential influencing port performance. Chapter 3 represents the four port governance models. It defines the each port model descriptively and explicitly. Chapter 4 explains the relationship between risks and port activities and defines the concept of risk allocation and risk mitigation in port sector. The primary objective of doing so is to understand each concept that would help in next chapters. Chapter 5 considers the risk analysis in the service port model. It evaluates each risk and risk factor in service port model and illustrates the case study the port of

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Latakia, Syria to show how public authority assesses, allocates and mitigates risks in real practice. Chapter 6 describes risk and risk factors considering port authority and private cargo-handling firms in the tool port model. It also considers the case study-the port of Shahid Rajaie, Iran to show risk allocation and mitigation between port authority and private firms in tool port model. Chapter 7 defines the risk and risk factors in the landlord port model and risk allocation between port authority and private sector in different forms. Three case studies are taken into consideration under the different forms of the landlord port model to show how risk allocation and mitigation processes have been applied by relevant parties in the real practices. The three case studies are the port of Maputo, Mozambique under the form of BOT, the port of Long-beach, USA under the lease agreement and the port of Xiamen, China under the joint venture. Chapter 8 explains how private sector deals with risks in common practice under the private port model giving example of the port of Felixstowe, UK Chapter 9 refers to risk analysis framework that has been drawn based on the previous chapters and case studies. Risk analysis framework is categorized in to three stages: risk identification, risk allocation and risk mitigation. It should be considered by port authority or/and private sector before making decision of investment in port facilities. Chapter 10 provides the conclusion and identifies some areas for future work.

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2 2.1

Risk in Port Finance Introduction

In the past the fundamental role of port was to generate employment and develop local infrastructures. Therefore analysis of port investment and management only considered the ports role in the promotion of regional and national economic development. Consequently, quantification of risks was not a significant part of port investment and management appraisal. However in current port project2 analysis, risk-return or financial risk assessment is an absolute requirement due to an increasing degree of private sector participation in port sector. The aim of this chapter is to describe: Major risks involved in port investment and management Risk factors that make port investment and operation more complex and revenue uncertain.

2.2

The Concept of Risk

The term risk does not have universally agreed definition. Each group of researchers h their own perception of the concept of the risk. In the field of as finance a very common definition is 3: A risk is any unintended or unexpected outcome of a decision or course of action Here unintended and unexpected outcome implies only a possibility or probability of outcome, as distinct from a certainty. Risk implies chance therefore it is characterized by uncertainty. From the given definition it is ascertain that risk is an unavoidable feature of decisions or actions carried out in everyday business activities. Following definition also gives a further idea of the risk. Risk can be defined as expected adversity E (A). It can be estimated as the product of the probability (pf) of adversity or failure and the magnitude of the possible adversity (A). Adversity is the loss or disutility expressed in terms of money or some other quantifiable attribute, which permits risk to be expressed as 4

E (A) = p f * A (1)
Firm, company or organization can not survive in todays increasingly sophisticated and competitive market for very long without taking risks. At managerial and operation level, firm or company is confronted by threats from product failure, incompetent market strategy, introduction of new technology, entry of new
2 3

port project and port finance refer to port investment and management F. Wharton, 1992, page 5, Risk Analysis, Assessment and Management 4 Financial risk of port infrastructure development, by Ryuli Kakimoto and Prianka N Seneviratne

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competitor in market, economic disaster, political upheavals etc. Company struggling to survive in competitive environment must concern about problems of business risk management.

2.3

Risks involved in port investment and management

Port industry is a service sector and the demand for its service is fundamentally derived demand and depends upon regional and international trade. Like other service sectors, existence of port in the competitive market solely depends on the two basic underlying forces demand for port services and supply of port services. The demand for services is influenced by the cost for using port and the quality of services expected by customers from the port. While the supply of port services refers to the quantity and quality of services, a port itself is willing to provide subject to the payment received from the customer. Particularly, Port industry is struggling with the risk factors that concern national and international trade, political instability at regional as well as at global level, environmental damages, and security threat (terrorist attack) etc. Decisions made by port authority or port operator are often fraught with risks not only for them but also for shareholders and perhaps country where port is located. Following figure shows the major risks in port investment and management.

Financial Risk Monetary Risk Construction Risk

Commercial Risk

Major Risks

Country Risk

Environment Risk Operating Risk

Social Risk

Figure 2: Major risks in port investment and management

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Risks and the factors responsible for them described below could adversely affect port operation, management and investment and result in loss of all or part of investment. Therefore it is prerequisite to identifying risks and determining optimum risk allocation between different participants for success of any port investment and management. 2.3.1 Construction risk

Construction risk mentions risk associated with construction of the project. Construction cost generally overruns in long term project. It was found that the difference between actual and estimated construction cost varied from 10% below to 500% above (Skamris and Flyvberg, 1996). When a project is entirely financed from public budget, construction risk may increase the cost for port authority when completion of port project is delayed due to inability and unwillingness of government to make appropriate investment. It has been found in many port projects that government neglected or postponed construction work due to financial deficit. Construction risk also increases the cost for the private sectors in terms of a loss of earnings, proliferation in interest charges due to delay, and penalties paid to concession authority or/and customers under contractual regulations (World Bank, 2001).The principal causes for excess cost or delays are uncertainties of time duration of construction project, inadequate assessment of labor issue and ability of supplier and sub-contractor, and underestimation of quantities of material, material price. In some cases, government or concession authority modifies project framework by introducing new clause subsequent to signature of contract that increase project cost or delay completion of project. In such situation, it is desirable for operator to engage with project from initial stage (design phase) and shape the project in such a way that may reduce technical hurdle. When operator does not involve in the construction phase of project, he must analyze the project specifications and propose alternatives in case of certain unacceptable aspects, however he has to accept a less than optimal design (World Bank, 2001). Port authority or operator can manage construction risks through making a construction contract or a design and build contract with primary construction company under which primary company is bound to complete construction of project in given period with performance guarantee and appropriate penalty clauses. However operator must identify credit risk for Construction Company by careful inspection of companys capacity to stick with its technical, financial and contractual commitments (World Bank, 2001). 2.3.2 Social risk

Social risk is very often based on the quality (efficient, skilled, well educated and trained etc) of the labor force, national law regarding labor force, interference of labor-unions in port operation and management. In many countries, a special status has been given to Dockworkers under the national law that increases the cost for port operation.

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Port authority or private o perator may incur a loss in terms of cost of severance payment, retraining etc while restructuring workforce. Whenever labor cost becomes too expansive and raises port tariff, ship owner or shippers try to avoid the port and use a neighboring port. Weak labor force can be responsible for low production level; high damage level and theft due to high interference of labor union, and strike. 2.3.3 Financial risk

The general definition of financial risk is the possibility of not succeeding in bringing a return on a given investment or loan, and a loss of original investment or loan. In port projects, financial risk can be different for government, commercial institution and private sector. When a project is financed from the public budget, financial risk associates with the under-utilization of port facilities that fails to the improvement of economic conditions and employment. In the case of financial institutions, financial risk arises from the possibility of not backing up the commercial debt and the inadequate political risk guarantee for debt. For the private port operator financial risk relate to the raising shareholders equity or loans required for funding project and failure of bringing in expected reasonable rate of return on investment (World Bank, 2001). This is the foremost risk making participants unable to support financially the port project and thus putting the whole project in jeopardy. Government needs to make a large investment and to follow appropriate operation and management in port for improvement of economical development. Even though the aim of government does not make financial return, project must be assessed properly to eliminate financial risk because the opportunity cost of the port project is very high especially the project is completely financed by government. When a project is financed fundamentally by financial institutions i.e. commercial banks, and multilateral institutions, political risk guarantee is extremely important for commercial senior debt. Also, the structure of projects should be made in such a way that the minimal financial risk is left with private sectors, and lenders are not vulnerable to any additional risks unrelated to the project itself (cadwalader)5.

Financial risk generally arises due to following factors: 1. Lack of ability of government: It refers to governments inability to finance projects. In the past many port projects were neglected or postponed during the period of fiscal deficit. For example, infrastructure investment (US $ 23.4 million) was called off for the port of Buenos Aires between 1988 and 1990 due to fiscal turmoil in Argentina (Tomas Serebrisky) 2. Lack of proper advice to government: In many cases, it has been found that even though government has been able to finance projects, it has failed to organize projects due to lack of proper advice regarding appropriate tools or techniques which must be implemented properly for success of projects.

International securitization & structured finance report, May 15,2003, volume 6, no.9

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3. Lack of understanding the project structure: In the developing countries, central government overemphasizes attracting private investment in port projects. They are increasingly amending contract based regulations for firming up the commitments of all parties involved in projects without understanding carefully contract design which anticipates problems and addresses unpredictable situations. This increases the regulatory and political risks which make the future project more expensive and difficult. 4. Inappropriate concession agreement: A concession agreement should be bankable. It should leave minimal risks with private operator. Also, it should make available some support packages in relation to certain risks i.e. political risk, construction risk, legal risk, environmental risk etc. and should provide full or partial risk guarantees from multilateral institutions i.e. MIGA(Multilateral Investment Guarantee Agency) (Cadwalader)

5. Inadequate or lack of Political risk guarantee: The political risk guarantee is


an instrument that protects the commercial lenders against the effect from the political event within country. An Inadequate or a lack of such guarantee generates significant risk of not getting back the commercial debt. 2.3.4 Commercial risk

Commercial risk is caused from the financial viability of revenue raised from everyday port business (income raised from providing port facilities to customers). It can be defined other way as revenue risk that the earning capacity and throughput of the port or terminal may decline simply because of rectification in the strategy of other port or terminal operators seeking to enhance their market share. In general, strategies include a competitive tariff, an expansion or improvement of existing physical facilities, marketing, and other traffic generating approaches. However, following paragraph obtained from the port sector report prepared by Asian Development Bank explains commercial risk explicitly. Commercial risk refers to the risks associated with the financial viability of revenue of the project. These include the risks that the demand will not be sufficient or will not support a sufficient level of charges and that the capital and operating expenditures will be significantly higher than anticipated. For ports, the risk is increased by the changing patterns of international trade and waterborne commerce. The growing competition between intermodal routes and the control of the shipping lines over the routing of vessels and cargos has added to the commercial risk. The greater this risk, the higher the projected return that the private sector will require before entering into agreement(page 52,port sector report, Asian Development Bank). Commercial risk has two components traffic risk and tariff rate risk. The service provided by port is merely a part of a global supply chain, of which port is considered as a single element. In this case port takes part with other players of an integrated transport and logistic chain. Ship owner and shippers are principal customers of the port. In the case of ship owner, the integrated service covers all operation activities needed for ships call. Even though operator provides the most sensitive and costly part (handling and

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storing) of a service of call, vessel also requires suitable maritime access, pilot, tuges, operation buoying, EDI and VTS traffic control systems. All these services provided by other private companies or port authority are not under control of operator. Therefore, ship owners decision to use operators services also depends on the factors out of control of the terminal operator. These factors are responsible to generate a further commercial risk for the private operator (World Bank, 2001). For the shippers, integrated service covers end t end service, in which port is o merely a node. This means shippers require not only port services but also efficient hinterland connections as well as co-ordination of these services with port services. Furthermore, government functions especially custom rules and practices have been considered carefully by shippers. In this context, it is clear that port does not have control on the factors responsible for shippers decision to use operators services. Such situations also create commercial risk for the operator and make difficult to compliance with contractual rules and regulations (World Bank, 2001). Following Factors are responsible for commercial risk: Shipping industry: The traffic level of port is subject to cyclical fluctuation in the shipping industry Continued growth of world and regional trade: Transport cost is considered to be significant part of international trade. More than 70% of world cargo is carried by maritime transportation. Thus development in international and regional trade directly influences the demand for port. Increase in vessel size: Over the last decade, technological development has accelerated the vessel dimension in such a way that seems to have no limit in the vessel size. This uncertainty in vessel size creates more challenges for ports. Larger vessel requires new large dock gantry cranes and extensive dredging that involve a huge investment. Therefore, to establish new facilities anticipating new size dimension is a quite risky task (Brian Slack, 2001). Global and regional economic condition: The volume of global trade can be affected by changes or development in the global economy i.e. USA, China or European countries. For example an economic up or downtrend in china may adversely affect the import or export from china that has a direct im pact on international trade carried out mostly by shipping transport. As a result, the throughput of ports located in Europe, USA and Asia or/and elsewhere around the world can be reduced dramatically. Consolidation among ocean carriers: Over the last decade, several firms (carries) have come together i.e. NOL-APL, P&O Nedlloyed, and Maersk-SeaLand, to respond adequately to globalization. This new trend towards substantial consolidation among carriers generates enormous influences and new uncertainty for port demand. Consequently, ports have been forced to provide adequate facilities and services despite the financial, commercial or ecological

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consequences. Many ports have had to expand terminal facilities setting new equipments and superstructures, and d eepening and extending berths. Many times these investments have not been succeed and made a huge loss (Brian Slack, 2001). Location of port: Geographical location of port will play an essential role for determining the volume of cargo that can be handled by the port. Inter & intra-port competition: It refers to a degree of competition within port and between neighboring ports and a policy of neighboring terminals or ports regarding services, tariff, expansion of terminal facilities etc. In inter-port competition, inland transport system is the major factor arising competition among ports within same region. It determines to a great extent the competitiveness of port. The involvement or interest of freight-forwarders and multimodal transport operators in specific port, the price-quality ratio from the perception of carriers which provide door to door services, a role of port in a VAL system, proximity of port to consumer or industrial areas also stimulate competition. In intra-port competition, competition risk arises in connection with volume discount, guaranteed vessel turnaround time, competitive tariff methods, and EDI services. Proximity to industrial areas and resource industries: Demand for port is increased with industrial development of the region where port is located. Therefore any rise and fall in industrial production directly influences port throughput.

Location of domestic consumers: Cargo volume of port will increase


or decrease with fluctuation of local consumer demand for goods. As long as demand increase for more goods, cargo level of port will also increase. If consumer demand decreases, cargo volume will follow same trend and thus it will fall.

The availability and relative costs of intermodal transports from port


to markets: Today, the success of port is exclusively based on adequate hinterland connectivity with port. The lack of inland transport connection influences the commercial risk. Furthermore congestion problem is also as much important as an issue of hinterland connection itself. Severe highway congestion for example, limits container movement by truck from the PNYNJ (port of New York and New Jersey) to hinterland markets in the northeast6. Therefore operator should also take into consideration congestion problem that may arise in coming years. In high competitive environment, port authority or government must promote an efficient intermodal system and create a new relationship with other transport modes in order to secure cargo or market share. In India for example,
6

Comprehensive Framework for sustainable container port development for the United States East Coast

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lack of back up transport infrastructure in ports result in higher transport cost. 2.3.5 Country risk

Perception of country risk is one of the prime drivers of any investors decision therefore understanding of such risks is very important. Country risk is closely related to future investment return. Country risk arises in connection with unstable political and economical systems of a country where investment is made. Political conflict, unstable government systems, inconsistent institutional reforms, and unfavorable government policy can have profound negative impact on investment and management decisions. Following figure shows the political, economical, and financial risk factors that are important for assessing a country risk. Investor has to consider all factors before making decision of investment in a particular country. Political leadership Corruption in Government Civil war Quality of bureaucracy

Political Factors

Economical Factors

Fiscal Policy Trade balance Inflation International Liquidity Ratio

Legal Factors
Figure 3: Primary factors for a country risk

Law and Order tradition Contractual agreements Misinterpretation of law Possibilities of changes in the applicable law

Source: International Country Risk Guide

In the case of port investment and management, Country risk refers to the risk resulting from legal, social, economical and political activities of the country where port is located. 2.3.5.1 Political risk Political risks, as defined as non-commercial risk, are inherent and often hidden in a countrys political, business and cultural environments. They have financial, operational, security and reputational impacts7. Corruption, bureaucracy, political
7

John Maltby & Matthew Horrox, institute of risk management

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shift, terrorism, legal and regulatory irregularities can be primary sources of political risks. Political risk is one of the significant risks involved in port project. Political risk arises from the unforeseen actions, decisions or inactions of a port authorities or public entity. Here, inaction implies clearly the non-compliance of the contract by the port authority or government. This risk can distress the ability of operator for repayment of loan to banks and lenders, and profitability of all types of contract and investment made by operator. When private sector makes investment in country where political as well as economical stability is highly unpredictable and complex, political risk influences highly the port project. It is quite difficult to evaluate reliability of local infrastructures, labor force, suppliers and service providers, and government and legal services. Over estimation of government actions may result in expropriation, nationalization, and inefficiency in applying legal system. Political risk appraisal is always complex matter and there is no any means, hedging or guarantee that eliminates risk entirely. As described above, political risk arises from non compliance of the contract by port authority or government, the effectiveness of contractual commitments of such parties depends on the credibility of applicable law and regulation. Legal system must be formed on the basis of international rules and regulations. As appropriate legal system is not only enough for managing political risk, operator may call for involvement of multinational organization such as World Bank, Asian Development Bank, International Finance Corporation etc. The presence of such multinational organizations in port project forces government to avoid imposing any measures that put project in jeopardy (World Bank, 2001). Other approaches for protecting against political risk are financial involvement of sponsors or lenders of host country, guarantee from export credit agents i.e. Exim Bank or COFACE during loan period (World Bank, 2001). 2.3.5.2 Economical risk

Economic al risk refers to risk resulting from the significant changes in government policy or/and in macro-economic factors. It has an indirect consequence on port activities. This risk arises from business environment within country. The development of technological infrastructure, economic performance, government efficiency, quality and productivity of workforce, business efficiency etc are competitive factors that determine the countrys competitiveness in the international business and trade, and global market. Countrys competitiveness is one of the crucial factors that foreign investor always considers in risk-return analysis for investment in particular country. The higher the countrys competitiveness, the more the flow of Foreign Direct Investment (FDI) in country will be. The more the FDI flow in the country, the higher the growth of industrial production will be. Consequently, demand for port raises to manage international trade that results in higher throughput of the port.

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Following table gives comprehensive explanation of factors responsible for economical risk.
Table 1: Responsible factors of economical risk

Government Policies Fiscal policy: - government expenditure (Investment vs. spending), tax-policy (rate of taxation), governments debt situation (size of external and internal debt, management of debt etc.) Monetary policy: - inflation, real or nominal interest rates, money supply growth, financial sector/GDP. Micro-economic factors Markets:- size of market, market stability, aggregate demand, access to regional market, income level, production and consumption level, purchasing power etc. Competitiveness:- labor availability, productivity, labor cost, trade union power, availability and quality of physical infrastructure, inter and intra industry linkage, access to local capital, transport cost etc Resources: - availability of natural resources, accessibility and location.
Source: elaboration by author using various materials

2.3.5.3 Legal risk Legal risk links with insufficient precision or possibility of changes in applicable law and regulation that affect or reduce the ability of port authority or/and port operator to carry on operation and management of port. Misinterpretation of law and regulation also create the legal risk. In many cases, extreme complexity and variety of interpretation of law and regulation lead to dispute between port authority and operator (World Bank, 2001). Private sector can lessen legal risk somewhat prior to contract through legal analysis undertaken by private sector himself or, indeed it is worthwhile, by local legal advisor specializing in the various disciplines. However in many cases , private sector has ignored to comply with applicable laws and regulations that create extreme conditions under which he is exclusively responsible for any adverse consequence (World Bank, 2001). Operator can call for legal security against the risk resulting from possibility of changes in legislation and regulation at later date. Stable guarantee or inclusion of contract revision clause in the contract could be an ideal tool to avoid unfavorable situations where changes in legislation may put the financial viability of the project in jeopardy (World Bank, 2001). However, in the case of intra-port competition it is not justified to provide guarantee only one operator at the expanse of fair competition among operators with jeopardizing public service (World Bank, 2001). Contractual risk is also the part of legal risk. It is a fundamental risk for both port authority and private sector. Contractual risk, in case of private participants, arises in connection with a set of measures impose on operator that may generate project cost or/and commercial risk. Port authority may bear this risk to a great extent when private operator becomes unable to continue the project. Port authority regulates economic and technical measures to restrict the operators actions for abusing of dominant market position. The objective of imposing regulation is to protect users and general interest. But in other side, private operator seeks to carry out its

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activities under the market condition and thus he wants a greater freedom of action in management of the project. Operator must carry out all activities under the regulations imposed by port authority, and disciplines imposed by market condition. In this context, it is quite complex for private operator to determine how to share a commercial risk with concession authority and thus it increase cost for operator. Contractual risk also generates an additional cost for port authority in terms of compensation to private operator, inspection etc. 2.3.6 Monetary risk 8

Monetary risk refers to risk related to fluctuation in exchange and interest rate, nonconvertibility of the local currency into foreign- currenc y and non-transferability. This risk is higher in those countries where political condition is highly unstable, economy is weak and government policy does not attract Foreign Direct Investment (World Bank, 2001). Exchange rate risk - variability in the value of project or amount of loan resulting from unpredictable fluctuation in the exchange rate - has become a supreme consideration of private operator, if guarantee can not be obtained from government or central bank of host country. Optimal risk allocation principle to assign risk to party best able to manage it - does not work out for exchange rate risk in port finance. Operator can pass on some or all of risk to third-party by contractual arrangement (Swap contract). Following figure gives general idea how port authority or private operator can reduce or mitigate monetary risk through a swap contract.
Port Authority or Private operator Counterparty

Fixed Euros Fixed US $

Fixed US$
Lenders or Suppliers Figure 4: Swap contract

Euro variable rate


Exchange Rate Market

US$ variable rate

Monetary risk can be hedged or eliminated by different ways. Off-shore account with approval of local authority can eliminate whole risk raised through non-convertibility or non-transferability of local currency. But where operator cannot obtain authorization for off-shore account, guarantee for convertibility or transferability from government or central bank of host country would be best approach to protect project against monetary risk (World Bank, 2001).

Monetary risk is the part of financial risk. Author believes that it can be explained explicitly by separating from financial risk therefore it is separated from financial risk.

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2.3.7

Operating risk

Operating risk results from ports day to day management and operational functions. The likelihood and impact of the operating risk on port activities is based on the operational framework in respect of allocation of functions, powers and responsibilities between different departments or/and between p authority and ort private operator. When port is financed from public budget it is important for government and port authority to understand the whole operational mechanism and relationship between different departments for port management and operation activities in terms of powers and responsibilities. Overlapping of responsibilities can be one of the major causes for operating risk in public owned ports. In the case of port operated by private sectors, operating risk arises from the not fulfillment of contractual obligation regarding cargo traffic by operator. Operating cost overrun due to underestimation of operating cost in the project appraisal is the major factor of operating risk. (World Bank, 2001) 2.3.8 Environmental risk

Nowadays, the major challenge ports face is the environmental concerns. Concern about environment and safety of marine surroundings has increased dramatically over last decade. International and regional laws and regulations regarding environment and safety have been implemented very strictly in the maritime industry. Today, transport policies in respect of shipping and port sectors are expressed largely in terms of their potential impact on environment and expected level of pollution 9. Such significant development of environmental policies in maritime industry has changed profoundly the whole structure of transport and port sectors. In the port industry, the environmental risk is caused from dredging, bunkering activities, reception of ships wastes, cargo spillage, ballast water, noise, dust, intensive lighting, emissions from ships and land-side transport vehicles, vessels and equipment repair and maintenance, contaminated water, dredging disposal, contaminated land, habitat loss, and industrial effluent Concerns relate with dredging, filling of open water area (massvlakte II, Rotterdam), localized traffic and other potential adverse environmental effects of port activities (Thomas A. Grigalunas, Oct. 2001)10 often delay and hamper port development. The one of the major factors for environmental risk is Intervention of Greenfield group and Changes in environmental regulations.

ESPO-environmental review report published in 2001 Comprehensive Framework for sustainable container port development for the United States East Coast
10

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3 3.1

The Port Governance Structure Introduction

The recent movement toward private sector participation in port sector has brought in different port governance structures around the world. Government devaluation programs have responded to two drivers of changes first, rapid improvement in information technology forcing the transparency of government operations and second, inability or unwillingness of government to make large investment in port sector due to lack of public confidence in government activities and increasing deficit and debt burden (Mary Brooks, 2004). The choice between four port management models i.e. service port, tool port, landlord port, and private port depends on how responsibilities are allocated between public and private sectors at optimum level. This chapter focuses on different port governance structures described in World Bank Port Reform Toolkit.

3.2

Port Governance Models

The fundamental institutional reform in port investment and management functions has spawned new boundaries between public and private sectors. Most countries have undertaken different types of specific tools and methods to make privatization program successful and to release bottlenecks to trade and economic development. The choice of specific port governance modal depends on the socioeconomic structure of country, location of port and the way the port organized and managed. However, such institutional reform should be carried out in such a way that arise benefits not only for government and private sector but also for shippers, exportersimporters and consumers. Before different port governance models can be explained it is important to understand what the port governance model and different port activities are. Port governance model is the system by which rights and responsibilities in respect of investment, regulatory and operational functions are assigned to different participants i.e. governments(central, state and municipal), port authority, private sector involved in port investment and management. It also sets out the objectives, rules and procedure for decision making, and the strategies for obtaining defined objectives. Private sectors include terminal operators, cargo-handling companies, shipping lines, forwarding agents, inland transport operators etc (World Bank, 2001). Each port governance model has different objectives. Port governance models are different from one other on the basis of allocation of rights and responsibilities of investment, regulatory and operational activities. Following figure classifies port activities into investment, operational and regulatory activities.

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Figure 5: Classification of port activities

Port activities

Investment Activities Port Basic Infrastructures Port Operational Infrastructures Port Superstructures Port Equipment

Operational Activities

Berthing
Pilotage Towing Tying

Cargo-handling
Stevedoring Terminal Storage Freezing

Consignees
Admst. Paperwork for ships and cargo Customs permits Service hiring

Ancillary
Marketing Repairs Suppliers Cleaning Refuse collection

Regulatory Activities

Licensing Permitting

Environmental policies

Port safety and security policies

Labor regulation

Source: Elaborated by author using port economics lecture slides.

Investment activities refer to investment in various port assets i.e. port basic and operational infrastructures, superstructures, and equipments. Operational activities can be classified into four stages (1) berthing activities: pilotage, towage and tying (2) cargo-handling activities: stevedoring, terminal, storage, freezing etc (3) consignees activities: administrative paperwork for ships and cargo permits (custom s and sanitary), services hiring etc (4) ancillary activities: maintenance and repairs, marketing of location and operation, employment and training of labor force etc. Regulatory activities point out licensing, permitting, custom regulations, labor regulation, environmental policies, protection of port safety and security, vessel traffic system etc. Here, port assets can be classified into port basic infrastructures, operational infrastructures, superstructures and equipments. Following table shows port assets classified in to above-mentioned categories.

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Table 2: Classification of port assets

Port Basic Infrastructures


Maritime access channels Port entrance Protective works including breakwaters, shore protection Sea locks Access to the port for inland transport (roads, tunnels, etc.) Rail connection between the hinterland and the port Inland waterways within the port area.

Port Operational Infrastructures


Inner port channels, turning and port basins Roads, tunnels, bridges, locks in the port area Quay walls, jetties and finger piers Aids to navigation, buoys and beacons Vessel Traffic Management System (VTMS) Port land (excluding superstructure and paving) Access roads to general road infrastructure Rail connection to general rail infrastructure, marshalling yards

Port Superstructures
Paving, surfacing Terminal lighting Parking areas Sheds, warehouses and stacking areas Tank farms and silos Offices Repair shops Other buildings required for terminal operations.

Port Equipments
Cargo handling equipment (apron and terminal Line handling vessels Dredging equipment Ship/shore handling equipment Tugs

Source: World Bank Port Reform Toolkit, 2001

World Bank port reform toolkit has drawn the four different port administration models a explained the allocation of responsibility and right for different port nd activities between port authority and private sector. These four port model are 11: Service port modal Tool port modal Landlord port modal Private port modal

Service and tool port models tend to focus on public interest. Landlord ports have mix approaches of public and private port model with the aim of balancing between port authority and private sector interest. While fully privatized ports focus on private shareholders interest (World Bank, 2001).These modals differ from each other on the basis of the role of public sector and private operator, their orientation,

11

Author has used MEL thesis 2003/2004, Private Sector Financing of Container Terminal Infrastructure, by Michele Acciaro, to explain four port models

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ownership of superstructures and capital equipments, provisions of labor and management. 3.2.1 Service port model

Service port model is entirely dominated by public entity. Under this port model, port activities - investment, operational and regulatory - are provided by public port authority. Port authority installs, maintains and operates all infrastructures, superstructures and equipments. Cargo-handling activities are operated by port labor employed by port authority. Usually, port authority makes the decision in respect of operational and management activities while decision about investment in infrastructure and superstructure can be made by ministry of transportation or/ and communication (World Bank, 2001). In some cases cargo-handling systems are operated by separate public entities. However, such arrangement might create serious challenges for port authority and ministry of transport because separate public entity operates cargo-handling activities with different objectives from port authority b report to same ministry ut (Mary brooks, 2004). Such problems were seen in African countries- the port of Mombassa, Kenya and the port of Tena and Takordi, Ghana. Afterwards port authorities and cargo handling company were merged into one single entity in both countries Kenya and Ghana (World Bank, 2001). Generally, private sectors have not taken part in the service port model but some of the operational activities may be undertaken under contract by private firms, with exclusive control of this operation condition reside with central, state or municipal governments (Mary brooks, 2004). The strength and weakness of the service port model are shown in the following table.
Table 3: Strengths and weaknesses of the service port model

Strength
Right and responsibility to same organization (Unity of command) Public interest Port remains the public asset

Weakness
Less problem-solving capability & flexibility Lack of internal competition Wasteful use of resource Government interference Less market-oriented operation Lack of innovation Dependence of government budget Limited role of private sector

Source: elaborated by author using World Bank Port Reform Toolkit, 2001

Labor problem is one of the major weaknesses of this model. Lack of capability and flexibility of port authority to solve labor problems, and serious interference of labor union in operational and other port activities reduce the port competitiveness (World Bank, 2001).

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Service port model tends to focus on public interest, in other words the objectives of Service model are to improve regional and national economy and employment rather than making financial return on investment (World Bank, 2001). Service port model is not used often nowadays. Typical examples of service ports were found in Asian countries especially in India, Philippines and Sri Lanka. Until 1996 Singapore port was also operated under service port model (World Bank, 2001). Following table represents distribution of responsibilities - investment, operational and regulatory of port activities in the service port model. As explained earlier, the service port model has predominantly public character; therefore, responsibilities of all activities are assigned to the port authority alone.
Table 4: Distribution of responsibilities of port activities in the service port model Functions Responsibilities Port Authority Private Sector Investment Investment in basic infrastructures Investment in superstructures Investment in operational infrastructures Investment in port equipments Ownership of land, infrastructures and superstructures Management (regulatory & operational) Employment of dock labor Cargo-handling activities Pilotage, towage, ancillary & other services Maintenance of basic and operational infrastructures Maintenance of superstructures Maintenance of equipments Marketing of operation Marketing of port location Environmental policy for marine pollution Protection of the interest of public safety & security Port facilities security Customs regulation Regulation regarding port-labor force Source: Elaborated by author using World Bank port reform toolkit.

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3.2.2

Tool port model

In the tool port model, the port authority is responsible for investment, development and maintenance of necessary infrastructures, superstruc tures and cargo-handling equipments such as quay cranes, forklift, trucks etc. for efficient port activities. Port authority rents out cargo-handling activities to private cargo-handling firms on short term lease contract. Private cargo-handling firms operate operational activities on board vessels as well as on the quay apron and within terminal. Port authority owned equipments are generally operated by port authority staff. This arrangement can lead to conflicts between the stevedoring companies, port labor staff and port authority (World Bank, 2001). Private cargo-handling firms usually make the contract with ship owner or cargo owner. The cargo-handling companies tend to be small with few capital assets. Thus, the lack of capitalization causes significant constraints for cargo-handling companies to emerge as strong companies that could serve port facilities effectively and be able to compete internationally (Mary Brooks, 2004). The one of the essential problems stevedoring firms face in tool port model is that they cannot have total control on operating activities. As result, they might face high commercial risk. Regulatory risk is also high in tool port model as operational responsibilities are not clearly defined among terminal operators and port authority. In order to provide effective port services to customers, some port authorities allow cargo-handling firms to install and maintain their own equipments on the terminal site (at that point it is no longer a true tool port model). The essential problem the port authority and private firms face doing so is conflicts with labor-unions. Private firms usually prefer to employ their own private work-forces to operate cargohandling equipments for becoming competitive in line with international market. But port labor-farce opposes such arrangement because they might lose their job. A number of ports of European countries usually are operated under tool port model (France, Portugal, Cyprus) although it is more common in developing countries. Ports Autonomes" in France is an example of a container terminal managed and operated as a tool port. This arrangement has generated conflicts between Port Authority staff and terminal operators, which has impeded operational efficiency. For more recent terminals, the private terminal operator has made the investment in gantry cranes (World Bank, 2001).
Table 5: Strengths and weaknesses of the tool port model

Strength
Avoidance of the duplication of the facilities Public interest Port remains the public property

Weakness
Under investment Lack of technology innovation Government interference Under utilization of port assets

Source: elaborated by author using World Bank Port Reform Toolkit, 2001

Indefinite split operational responsibilities between port authority and private cargohandling firms lead to conflict and reduce the port efficiency. Additionally, port

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authority bears the cost of the under-utilization of port facilities. Private stevedoring firms work as labor-pool and thus do not emerge as strong companies. There is a risk of under-investment and lack of technology innovation due to government intervention in port investment and management functions. The tool port model has similarities with service port model in the terms of the way it is financed. Also both port models have the same objectives: to improve economic condition of the region where it is located in terms of providing efficient services and improving employment. Hence, under the tool port model the primary role of port authority is to finance, manage and make available infrastructures and superstructures for private cargohandling firms to operate cargo-handling activities.
Table 6: Distribution of responsibilities of port activities in the tool port model Functions Responsibilities Port Authority Private Sector

Investment Investment in basic infrastructures Investment in superstructures Investment in operational infrastructure Investment in port equipments X Ownership of land, infrastructures and superstructures Management (regulatory & operational) Employment of dock labor Cargo-handling activities Pilotage, towage, ancillary & other services Maintenance of basic infrastructures Maintenance of superstructures Maintenance of equipments X Marketing of operation Marketing of port location Environmental Policy for marine pollution Protection of the interest of public safety & security Port facilities security Customs regulation Regulation regarding port-labor force Source: Elaborated by author using World Bank port reform toolkit.

(Note: X indicates separate responsibility of equipments and maintenance of equipments


installed by private sector and port authority. Here there is no allocation of responsibility between port authority and private sector. Private sector is responsible for investment and maintenance of only those equipments that installed by privet sector alone.)

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3.2.3

Landlord port model

Landlord port model has mix characters of public and private sectors participation in terms of ownership and operation of port facilities. It is an appropriate model for port management and operation activities because responsibilities of port activities are allocated between port authority and private sectors in such a manner that make port utmost efficient and competitive in the era of globalization. Port authority acts as landlord by providing mostly regulatory functions while private sectors carry out operational activities especially cargo-handling activities (World Bank, 2001). Port authority maintains the ownership of in port, and lease available port facilities to private operating companies. Usually port authority makes the investment in basic infrastructures and somewhat in operational infrastructures. Port authority is responsible for long-term development of port, protection of public interest, port safety and security, environmental policies for marine pollution, and maintenance of port basic infrastructures (World Bank, 2001). Private sectors make the long term lease contract with port authority for available port facilities. According to lease contract, private sectors have to provide and maintain necessary superstructures on terminal site. Private sectors are also required to purchase and install their own equipments required by their business. Private sectors are also vested with power/ authority of employment of dock-labor. However in some ports part of labor must be employed through a port-wide labor pool system. Under the lease contract, private sectors have to pay a determined amount of lease to port authority. This amount can be based on a fixed sum per square meter per year (World Bank, 2001). Nowadays, landlord port model is dominant port model in developed as well as developing countries. Shanghai, Mumbai, Yemen, Maputo and Dar-e- salaam are example of landlord port model in developing countries while Rotterdam, Antwerp, since 1997 Singapore, Long Beach, New York etc are examples in developed countries. As private sectors install and operate cargo-handling equipments and also carry out cargo-handling activities, the port is likely to be operated more efficiently. Usually, private sectors having particular skills and knowledge are better able to deal with changing environment of competitive market. They execute port activities considering what customers want and on that basis they provide customer and market oriented services. Also, retrenchment of additional, inefficient and outdated labor-force helps provide better services at competitive tariff. They are more likely to make necessary investment required by business policy. In the landlord port model t ere is a risk potential of over-capacity as result of h duplication of facilities by various private operating companies (World Bank, 2001). In accordance with above explanation about private sectors involvement in port activities it is ascertain that the port governance structure under the landlord port model favors trend towards expansion of privatization in ownership or/and management of port existing facilitate as well as development of new port facilities.

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Table 7: Strengths and weaknesses of the landlord port model

Strength
Single entity for operational activities Adequate investment Less government interference Loyalty of terminal operator to the port Maximum utilization Low or no assistance of public budget

Weakness
Over capacity Duplication of facilities

Natural monopoly (in some cases )

Source: elaborated by author using World Bank Port Reform Toolkit, 2001

Privatization is the process of reducing government role or increasing private sector role in production of goods and services in line with public interest and market demand. For port sector, following definition found in UNCTAD publication 1998 is more appropriate for explaining privatization. Privatization is the transfer of ownership of assets from the public to private sector or application of private capital to fund investment in the port facilities, equipments and systems. (Page 39, module 3: Alternative port management structures and ownership models. World Bank Port Reform Toolkit) Privatization can be classified into two categories (World Bank, 2001): Comprehensive privatization: privatization in which successor company takes the ownership of port infrastructures including land within port domain, superstructures and equipments, and responsible for all port activities. Partial privatization: privatization where a part of port activities usually operational activities transferred to private sector with the right of investment in port superstructures, equipments and somewhat in operational infrastructures.

Private- public partnership under the landlord port model falls into partial privatization category. Within partial privatization, a number of alternative modes have been existed in landlord port model. These alternative modes are as follow 12: Management contract; Leasehold agreement; Concession agreement (BOT, BOOT etc); Joint venture;

3.2.3.1 Management contract Under the management contract, government contracts out (based on a tender-bid procedure) certain non-core port functions to private sectors to improve port
12

Author has considered only those alternatives which are relevant to the thesis.

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efficiency and performance. Usually private sector carries out management functions for a fixed period. However, private sector does not involve in investment decision functions. It remains with government or public entity authorized by government. In addition, the ownership of the port facilities is resided with public entity (World Bank, 2001). Management contract is usually for three to five years and upon the expiration of contract period, government may either renew the contract or award new contract to another party. Government retains the right to impose financial penalties or/and terminate the contract in the case of inability of private sector to meet specific minimum level of efficiency, financial performance (World Bank, 2001). Management contract is an appropriate tool for those ports where (1). Port authority has no or little experience in port management and thus that result in poor management and increase port inefficiency (2). Cost of the contracting out of noncore activities is lower than the cost of undertaking them by port authority (3). Government believes that management contract would improve the financial condition of port authority. However, government or port authority might face the risk of monopoly of those activities, which would create contrary against the public interest when it (government or port authority) introduces management contract in port activities. Furthermore, government or port authority bears the operating risk. 3.2.3.2 Leasehold Agreement Under the leasehold agreement, port authority enters in to long-term lease contract and transfers the right to use port assets (infrastructures, equipments, or both) to private sector. Lease contract can be different based on provision of requiring funding contribution of private sector in port facilities. In a number of lease contracts, port sector is required to invest in superstructures and equipments while in others port authority makes the investment in all port facilities and lease to private sector. A widely accepted definition of lease is that it is an agreement conveying the right to use an asset (land or equipments, or both) for an agreed period of time in return for a payment or a series of payments by the lessee to the lessor. (Page no.8, Guideline... on the privatization of port facilities, UNCTAD, 23 September 1998) It is extremely complex to define precisely the responsibilities of private sector in terms of investment in port facilities under the leasehold agreement. It is entirely based on the objects of lease. Here, objects of lease can be defined as follow (responsibility of private sector): Investment in operational infrastructures (land side) and port superstructures and equipments Investment in port superstructures and equipments Investment in only cargo-handling equipments Fully equipped terminal with developed and surfaced land area including cargo-handling equipments, warehouses, offices, maintenance facilities etc

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The level of private investment is different in each object of lease. It is essential to define the exact object of lease in advanced in respect of the role of private sector, as this will have considerable consequences in respect of funding requirement of private sector, legal implications and duration of lease contract. As for duration of lease contract, this type of agreement will run for 10 to 15 years, 15 to 20 years or 20 to 25 years based on the degree of private sector investment in port facilities. The lower the investment made by private sector, the less the duration of lease contract will be. The construction of any permanent port facility or the installation of equipment by private sector requires a license from government. License of lease for water frontage and quay-wall with the obligation of construction of superstructures, installation of equipments, and performance of specific public interest have been common practice applicable to common user and dedicated port facilities 13. Under the leasehold agreement, port authority receives specified income from private sector. Today, financial arrangements between port authority and private sector with regard to lease payment can be determined by basic three forms: a flat rate, minimum-maximum rate and, a shared revenue lease. A flat rate lease: private sector acquires a right to use fixed port assets for specific period and pays periodic payment of fixed amount in return. The advantage of this kind of arrangement is that both parties know a lease amount in advance. Therefore, private sector has strong incentive to generate a level of business as close as possible to the maximum available capacity of terminal facilities 14. In addition, port authority gets fair return on the value of property. Flat rate arrangement is often better for those ports which primary objective is to maximize throughput and benefits to the local economy. However, port authority must be able to assess true value of leased port facilities and anticipate accurately the level of business (World Bank, 2001).

Figure 6: Comparison of lease systems

A minimum -maximum (mini-maxi) lease: port authority and private s ector agree upon the variable payment of amount with minimum and maximum limits. Payment of lease amount can be determined based on the activities performed with regard to
13

Guideline for port authorities and governments on the privatization of port facilities, UNCTAD report, 23 September, 1998. 14 Guideline for port authorities and governments on the privatization of port facilities, UNCTAD report, 23 September, 1998.

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utilization of available port fixed assets. Private sector has to pay specific minimum amount based on reasonable assumption of minimum throughput regardless of the actual volume of activity. A sliding scale method is applied for further payment until a predetermined maximum throughput is reached. Above predetermined maximum throughput, p rivate sector does not pay further rents to port authority. Under this method, port authority may not cover full interest and amortization of port fixed assets, in the case of minimum payment of lease amount (World Bank, 2001). With this form of lease, private sector will pay variable amount based on the tonnage or number of TEUs handled. Thus port authority and private sector share risk and reward of port investment and operation. Private sector tries to achieve traffic level beyond the maximum limit sinc e he receives the full benefits of any revenue generated beyond the maximum limit (World Bank, 2001). A shared revenue lease: Like mini-maxi arrangement, port authority passes the right to private sector to use fixed port assets for specific period in exchange for periodical variable payment of amount. Private sector pays a reasonable minimum amount at agreed bottom level but there is no maximum payment edge. Port authority takes part in terminal activities with private sector and share revenue of additional cargo handling activities above an agreed minimum level. In practices, shared revenue arrangement acts as a royalty system whereby a minimum rent has been defined and has been raised in line with increase in cargo-throughput level above agreed bottom level. Above-mentioned alternative modes of leasehold agreement do not indicate control by the port authority or government over the port tariff that private sector charges. In the flat rate lease, port authority receives fair return without taking part i cargon handling activities while under the mini-maxi and shared revenue agreements port authority executes cargo-handling activities and shares risk and reward with private sector. Finally, under the leasehold agreement, port authority acting as landlord provides basic infrastructures and some primary equipment units (depending on the objects of lease) while private sector becomes responsible for the 15: v v v v v v Investment in operational infrastructures(jointly with port) Investment in superstructures and cargo-handling equipments Ownership of port facilities ( jointly with port) Undertaking current operational port activities Maintenance of infrastructures and equipments Employment and recruitment of personnel

3.2.3.3 Concession Agreement Concession agreement is the contract by which private sector takes over the management of port activities with the obligation of investment in construction and rehabilitation of port basic and operational infrastructures, superstructures and equipments for specific period after which p facilities will be conveyed to port ort
15

Guideline for port authorities and governments on the privatization of port facilities, UNCTAD report, 23 September, 1998.

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authority. Concession agreement is a temporary privatization under which concessionaire creates, operates and delivers public services16. Therefore, the primary objective of concession agreement is to reduce the national deficit and promote private financing of public infrastructures. It is also known as Greenfield project Greenfield project: A private entity or a public-private joint venture builds and operates a new facilities for the period specified in the p roject contract. The facility may return to the public sector at the end of the concession period (world Bank Website). There are different kinds of modes namely BOT (Build-Operate-Transfer), BOOT (Build-Own-Operate-Transfer), BROT (Build-Rehabilitate-Operate-Transfer), BTO (Build-Transfer-Operate), ROT (Rehabilitate-Operate-Transfer), EOT (EquipOperate-Transfer) existed under the concession agreement. BOT, BOOT and BTO are major arrangements of concession agreement. Under the concession agreement, port sectors become the owner of port facilities during the effective terms of concession period and at the expiration of concession period facilities are transferred to port authority or government. Unlike lease agreement, the scope of concession agreement is not limited to superstructures and equipments but increasingly cover the investment in basic and operational infrastructures. Concessionaire is obliged to build and rehabilitate quay wall, dredging of harbor basin and channel approach, land reclamation, c onstruction of warehouses and wharves, construction of road between port and general road infrastructures etc. Abovementioned different modes of concession agreement sometimes generate uncertainty between government and private operator in order to understand clearly the terms and condition of agreement. Thus, it is appropriate to define the characteristics of each alternative modes of concession. 3.2.3.3.1 BOT (Build-Operate-Transfer) It is the common mode of concession agreement applied in most of the ports in the world. Private sector is assigned to right to build and operate the port facilities (port basic and operational infrastructure, superstructures and equipments) for specified (long) period afterwards facilities are transferred to port authority. Under this arrangement, port facilities never belong to (ownership) the private sector so at the expiration of concession agreement private sector is not able to receive compensation for the transfer of the facilities. After cessation of contract, port authority can lease out the facilities or, grant other concession with different objects, or make management contract. "A project based on the granting of a concession by a principal, usually a government, to a promoter, sometimes known as the concessionaire, who is responsible for the construction, financing, operation and maintenance of a facility over the term of the concession before finally transferring at no cost or at a predetermined price, a fully operational facility to the principal. During the concession
16

Guideline for port authorities and governments on the privatization of port facilities, UNCTAD report, 23 September, 1998.

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period, the promoter owns and operates the facility and collects revenues in order to repay the financing and investment costs, maintains and operates the facility and makes a margin of profit."(Denton Hall Projects Group; A Guide to Project Finance; 1998 Edition, p.47) Under the BOT arrangement, private sector charges the port tariff and collects all port dues. Payment to port authority can be fixed or revenue sharing basis. In some cases, private sector and port authority agree to share the profit (after deducting fixed and other costs) in the form of a royalty or a percentage on the net income from the concession17. BOT scheme can be apply either to terminal or to entire port area. Typical example of terminals operated under BOT scheme are JNPT- Nava Shiva, India, Port of Buenos Aires, Argentina and Queen Elizabeth terminal, Sri Lanka (World Bank, 2001). While example of entire port operated under the BOT, is Port of Maputo, Mozambique. 3.2.3.3.2 BOOT (Build-Own-Operate-Transfer) BOOT is similar concept of the concession to BOT. Under the BOOT arrangement, land and facilities are conveyed to private operator. Private operator takes the ownership of entire port facilities during the term of contract period. At the end of the contract, facilities are transferred to port authority at agreed price. BOOT is different from BOT with regard to ownership of land and assets, and transfer of port facility at agreed price. The port of Mundra, Gujarat, India is operated under the BOOT scheme. 3.2.3.3.3 BTO (Build-Transfer-Operate) Under this arrangement, private sector receives the right to build infrastructure facilities but he is required to transfer immediately all new port facilities to port authority or government after completion of construction and then operates port on the contractual basis for specified period. The reason behind such arrangement is that private sector receives the loan from lenders on concession agreement to build the port facilities. Here, concession agreement is collateral for securing loan. BTO is applied in the South Korea and Costa Rica where law does not allow private sector to take the ownership of port assets (World Bank, 2001). In the new port of Pusan, government awarded concession agreement under the BTO to New Port Co. with a 50-year concession period (www.strategis.gc.ca/country South Korea) 3.2.3.4 Joint Venture Joint venture refers to the self-governing (autonomous) organization established by two or more organizations with mutual interests. It can be set up either by different public organizations or by public and private organizations. In port sector, public port authority invites private sector to establish joint venture in the form of corporation (company) with separate legal entity. Joint venture is beneficial: to apply new
17

Guideline for port authorities and governments on the privatization of port facilities, UNCTAD report, 23 September, 1998.

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technology, to introduce better management practice, to create optimal infrastructures with using less national financial resources, to enhance the confidence of private sector in funding ports, and to share risks through pooling public and private resources. However, government concerns about ownership of port infrastructure facilities that foreign groups might take control of national assets. Joint venture is very often applied in ports in china. At the end of 1992, China government introduced Sinoforeign joint venture in port development project. The first Joint venture appeared when Hong-Kong based Hutchison Port Holding (HPH) started operation under joint venture in Shanghai and Zhuhai in 1993 (Wang, 2004).
Table 8: Distribution of responsibilities of port activities in the landlord port model Functions Concession Lease Joint venture Agreement Agreement Responsibilities Responsibilities Responsibilities
18

Investment
Investment in basic infrastructures Investment in superstructures Investment in operational infrastructures Investment in port equipments Ownership of land, infrastructures and superstructure

P.A.

P.S.

P.A.

P.S.

P.A.

P.S.

Management (regulatory & operational)

Employment of dock labors Cargo-handling activities Pilotage, towage, ancillary services etc Maintenance of basic infrastructures Maintenance of operational infrastructures Maintenance of superstructures Maintenance of equipments Marketing of operation Marketing of port location Environmental policy for marine pollution Protection of the interest of public safety & security Port facilities security Customs regulation Regulation regarding port-labor force Source: Elaborated by author

reform toolkit.

using World Bank port

18

Under the management contract, only certain non-core port activities are contracted out to private sector, therefore it might not be useful to show distribution of responsibilities of port activities under the management contract title in the above table.

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3.2.4 Private port model


This model is characterized by fully private sector ownership and operational responsibilities. In this model, port is no longer controlled by public sector. Private sector owns, develops and maintains port marine infrastructures, land, operational infrastructures as well as superstructures with equipments. Private sector is responsible for regulatory as well as operational functions. Labor force is employed by private sector (Mary Brooks, 2004). The majority of privatized ports are found in United Kingdom and New Zealand. One of the great concern government experiences in privatized port is that it (government) loses its control over the port in respect of protection of public interest and public involvement in developing long-term economic policy and strategies (Mary Brooks, 2004). Balthazar and Brooks (2001) describe the pitfalls to this model in following passage: If the government opts to privatize the regulator functions, the authors believe these should not be outsourced to the port. If this happens, as it sometimes does, the fox would be in charge of monitoring or overseeing the chicken barn, and the potential for abuse of the natural monopoly position that ports may enjoy increases dramatically.(Page no.171, The Governance Structure of Port, Marry Brooks, Review of Network Economics, volume-3, issue-2, June 2004)
Table 9 : Strengths and weaknesses of the private port model

Strength
Maximum investments and port operations flexibility Absent of government interference that increase port efficiency Market oriented port development and tariff policies

Weakness
Loss of control of government over port create monopolistic behavior Failure of ability of government to execute a long-term economic development policy with respect to the port business Government has to spend considerable amounts of money to buy back the port land Serious risk of speculation with port land by private owners

High price for the sale of port land in


favor of private sector

Ability of private sector to broaden


scope of port activities

Source: Elaborated by author using World Bank Port Reform Tool Kit, 2001

Following table explains responsibilities under the private port model. As explained earlier, the private sector owns all port facilities and performs operational and regulatory activities, entire responsibilities are assigned to private sector however, government drafts environmental law regarding marine pollution and custom regulations.

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Table 10: Distribution of responsibilities of port activities in the private port model Functions Responsibilities Port Authority Private Sector

Investment Investment in basic infrastructures Investment in superstructures Investment in operational infrastructures Investment in port equipments Ownership of land, infrastructures and superstructures Management (regulatory & operational) Employment of labor Cargo-handling activities Pilotage, towage, ancillary & other services Maintenance of basic and operational infrastructures Maintenance of superstructures Maintenance of equipments Marketing of operation Marketing of port location Environmental policy for marine pollution Protection of the interest of public safety & Security Port facility security Customs regulation Source: Elaborated by author using World Bank port reform toolkit

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4 4.1

Risk and Port Activities Introduction

In any sector including port industry, public sector or private sector or both together invest in particular activities with the intention to generate benefits for themselves and communities. But it can not be certain that every project will be performed successfully. They will be unable to perform and manage defined tasks due to shortfalls in finance and technical capacity, underperformance of project management, and of course poor assessment of risks, risk allocation and risk mitigation strategies. It results in loss of investment either public or private, public reputation, and the strength of institutions with regard to management strategy (a way of doing business). In previous chapters major risks and port activities in different port models are described. Risk can be high, medium or low based on the way the port activities are carried out, and the application of proper risk allocation and risk mitigation strategies. Thus it is worth describing the relationship between every risk and port activities performed whether by government or by private sector, and concept of risk allocation and risk mitigation in port sector. The intention of doing so s to understand the relationship between risk and port activities, risk i allocation and risk mitigation which would help understand risk, risk allocation and risk mitigation in case studies in different port models in next chapters. The questions this chapter is trying to answer are: How does each risk relate with different port activities? What is risk management (risk allocation and risk mitigation) in port sector?

4.2

Risk and Port activities

In port sector public or/ and private entities face a number of challenges raised from port activities. These challenges are highly inevitable causing different risks. Port authority, government or private sectors sometimes consider risk separately with a myopic lens and thus do not realize the possible affect of other associated risks on the port activities. To analyze each risk requires better understanding of the relationship between risk and port functions. Herein below each risk and particular port activities related with that risk are defined explicitly. Construction risk relates with construction of port facilities. Therefore it is caused from Investment activities in port basic and operational infrastructure, superstructures and equipments (port basic and operational infrastructures, superstructures and equipments are defined in the form of table no.2 in chapter 3). For example, construction of road and rail connection linking to port area to general road and rail infrastructures, dredging in harbor basin and channel approach, construction of warehouses, transit shades, yard area, offices, installation of cargohandling equipments etc. Social risk associates with operational and regulatory port activities with regard to labor force. Such activities include employment of labor force, training of dock labor, quality of workforce (skill, knowledge and experience), working condition of labor in

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cargo-handling activities in respect of working hours, wages, National labor law, negotiation with labor union etc. Financial risk also relates with investment and operational activities. It links with port investment and operational activities with the same manner as of monetary risk. Commercial risk associates with mainly cargo-handling activities, management and maintenance of basic and operational infrastructures, superstructures and equipments, management and maintenance of inland transport activities and marketing of operation and location Country risk is beyond the control of port authority and private sectors. It relates with investment, operational and regulatory activities. Usually it has huge impact on investment activities rather than other port activities. Political stability and countrys competitiveness in international market play important role to decide port position in the national development. Monetary risk connects with investment and operational activities. Investment activities have already been defined in earlier paragraph of construction risk. Operational activities in the sense of operating expanses and revenue generated from them. However it is necessary to understand how this risk relates with investment activities. Monetary risk causes the variation in the payment of loan, operating expanses and revenue by inflation, and interest and exchange rate fluctuation. For instance, if private operator takes the loan from lenders to make investment in port facilities, it would have to pay back the loan with specified interest rate, but due to inflation and exchange rate fluctuation it may pay more or less amount of loan instead of actual amount of loan and interest rate. In the case of revenue generated from providing various shipping and marine services to customers, private sector receives the payment in foreign currency but it might pay expenses in local currency. Consequently exchange rate fluctuation affect rate of return. In that sense monetary risk relates with investment and operational activities Operating risk links with operational activities. Operational activities consist of cargohandling activities, pilotage, tying and other operational activities, repairs and maintenance of superstructures and cargo-handling equipments etc. Environmental risk relates with construction activities of port basic and operational infrastructures and operational activities. Construction activities refer to capital dredging, handling activities of hazardous cargo, dredging in harbor basin and channel approach, filling of water area etc. Operational activities include bunkering activities, reception of ships wastes, ballast water, emissions from ships and landside transport vehicles, vessels and equipment repair and maintenance etc.

4.3

Risk Management

Although port sector has significant benefits in terms of high return on investment for private sector, and social welfare and economic advantages for public sector and communities, investment in port facilities and management of port operation remain extremely risky business. While considering port policy of countries, it is worth noting that each country sets out its own policy for the port sector which will be different from other country where transparency and general accountability does not

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have satisfactory importance. In such an environment, port authority and private sector face a number of unnecessary risks. According to common theory, these risks should be allocated to the party that can have the most control over the responsible factors that cause risks or/and the participant that has access to technique for mitigating these risk19. But in practice, assessment procedure of risk is more complex and extensive. Because all parties might have involvement in the responsible risk factors and they could apply different risk mitigation methods. Therefore it is important that risk allocation and risk mitigation should be applied appropriately. 4.3.1 Risk Allocation

Risk allocation is an exercise of deciding which party should bear the consequence of the occurrence of specific risk based on the evaluation of individual partys ability to assess, control and manage risk at best way. The allocation of responsibility for dealing with the consequences of each risk to one of the parties to the contract, or agreeing to deal with the risk through a specified mechanism which may involve sharing the risk (Glossary, www.vgpb.vic.gov.au) The appropriate risk allocation between different parties i.e. government, port authority, private sector, sub-contractor etc is based on the careful assessment of each risk in the terms of its consequences, evaluate the ability of parties for controlling and managing the risk and sharing risks among parties. Following chart explains different steps that must be consider while deciding risk allocation in the port sector.

Define the port project Identify the risks Evaluate the each risk in terms of consequence and occurrence Appraise the ability of parties to assess, control and manage risks Allocation each risk to parties best able to control and manage Share risks that beyond the control of all parties
Figure 7: Risk allocation Source: elaborated by author
19

Port sector report two, Asian Development Bank

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From the abovementioned chart, we can conclude that risks should be allocated according to the ability of particular party in the following manner: Risks within the control of private port/terminal operator: It refers that risks should be allocated to private sector that it is best able to assess, control and manage. Some of the examples are commercial risk and operating risk related to cargo handling activities, financial risk and monetary risk linking with investment activities. Risks within the control of the port authority: Port authority can bear the social risk, contractual risk and environmental risk. Risks within the control of sub-contractors: Port authority or private sector make the contract with experienced sub-contractors for construction of infrastructures, superstructures and equipments. In such a way, construction risk is allocated to sub-contractors. Risks within the control of lending bank: When port authority or/and private sector take the commercial loan from merchant banks to invest in port facilities, merchant banks would take the financial risk. Risks within the control of central, state or municipal government: Government plays a very important role to make success whole port project. Political risk, sovereign risk, social risk, environmental risk, and economical risk are allocated to government. Risks out of the control of all parties: Risks outside the control of all parties include force majeure events such as civil war, riot, war, act of foreign enemies, earthquake, flood etc. in the case of force majeure events it is important for all parties to clarify each events falling into force majeure and clearly identify risk allocation between parties. Risk Mitigation

4.3.2

The most primary task after risk assessment and risk allocation is to design the risk mitigation strategy. Risk mitigation will prevent the occurrence of risk or/and minimize the consequence of risks that do occur while performing different activities in business. Risk mitigation is the application of the deterrent technique to diminish the occurrence and consequence of risks. In the port sector, risk mitigation defines the role and responsibility of government, port authority, private sectors and landing banks in terms of management of risk potential at very conscientious way for smooth port activities. Nowadays, successful project financing in port sector rests on not only risk allocation and mitigation by public sector or private sector alone but unique risks must be allocated and mitigated by project lenders(merchant banks), project company parties (private sector) and sponsors (government and multilateral financial institutions such as World Bank, Asian Development Bank and IFC). It is important to understand how each party deals with the risks for preventing or minimizing the consequences of risks in risk mitigation. The following table

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describes the general view of risk mitigation process in port sector by different parties.
Table 11: Common risk mitigation practice in the port sector

Risk category Construction risk

Social risk Financial risk

Commercial risk

Country risk Monetary risk Operating risk Environmental risk

Force majeure

Risk mitigation -Public authority-: provides the project design, site data and operational information to private sector or construction company -Private sector: makes the contract with construc tion companies, with specified time for completion of work, with performance guarantees and penalty clauses. -Public Authority : absorb access labor by redundancy payment -Private sector: negotiates with labor-union regarding hiring and laying off workers. -Public Authority: provides political and economic risks guarantees. -Lenders: fixed interest rate on commercial loan, take performance guarantee and credit risk guarantee from private operator, receives political risks guarantee from government and multilateral financial institutions (MIGA guarantee) -Private sector: uses equity finance, obtains particular guarantees from government -Public authority: introduce fair competition, use performance contract, build or finance basic infrastructures and facilities -Private sector: makes marketing studies, provides efficient services with competitive tariff, user commitment etc -Public Authority : provides political risk & other risks guarantees -Private sector: marketing studies regarding countrys competitiveness, economic development, industrial growth, political configuration etc. -Public Authority : provides the guarantee for repatriation of earnings -Private sector and lenders: open off-shore account, make swap contract for interest rate and exchange rate etc -Private sector: uses fixed price contract, estimate accurately operating cost prior to agreement. -Public Authority: carry out environment assessment and issues environmental policies. -Private sector: draft environmental management and monitoring plans, passes onto construction contractor etc -Public Authority: includes force-majeure clauses in agreement -Private sector: takes adequate insurance coverage

Source: elaboration by using port sector report two prepared Asian Development Bank, and other different risk mitigation related materials (- Public authority refers to state government, municipal government, and port authority.)

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5 5.1

Risk Analysis in the Service port model Introduction

Port institutional reform in any country can be grouped in the four port models mentioned in the previous chapter. These four modals are distinguished on the basis of responsibility of government, port authority and private sector in terms of funding infrastructure, superstructure as well as port operation and management. In any case, the choice of port modals should be relied on careful risk analysis and optimal risk allocation between participants. The characteristics of each port model in terms of risk are different from one other on the basis of the degree of private sector involvement in funding, operation and management functions, approach of public sector regarding administration and control on port activities, legal framework and types (transshipment, gateway, export, import etc) of port. In the service port model, funding, operational and regulatory functions are undertaken entirely by public port authority. Therefore port authority bears all risks raised from port management and other external factors. The main objectives of this chapter are to define: What are the risk factors of risk in the service port model? Case study- The port of Latakia, Syria to understand how risks are allocated and mitigated by public authorities.

5.2

Risk and Risk factors in the service port model

As explained earlier in the service modal, port authority performs all investment, regulatory and operational functions. Thus all risks are allocated entirely to port authority. Below each risk is defined precisely in terms of their impact on port activities and responsible factors for that risk in service port model. Profound changes in maritime transport in the last two decades, makes ports capital intensive industries. To fulfill its function in new logistic chain, ports are required to invest substantial amount in new infrastructures and superstructures. In public port, port project is entirely financed by public budget. It has been found in many port projects that insufficient investment from government has generated high construction risk. In the past many port projects were neglected or postponed during the period of fiscal deficit. For example, infrastructure investment (US $ 23.4 million) was neglected for the port of Buenos Aires between 1988 and 1990 due to fiscal turmoil in Argentina (Tomas Serebrisky). Labor force is an essential key to success or failure of a port. Over-staffing, outdated, unreliable and inefficient labor force and complicated labor law increase the social risk. In service port model, l bor force has become immune to market a mechanism. Labor law is regulated on the basis of sociopolitical measures rather than commercial criteria. In many countries it has been found that government has postponed application of modern technology and institutional reform in the port

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sector to protect workers` job and income security. Furthermore, due to lack of commercial incentive, labor force is not as much skilled and trained as that of other port models. Poor skill and training reduce the ability of port to provide efficient and cost effective service. Therefore higher labor cost with low work productivity increase the social risk in service port model. In the service port model, port facilities are funded by government resources. Financial risk is associated with failure of port project that results in high opportunity cost. The likelihood of financial risk has been seen very high in the service port model especially in developing countries due to lack of ability and willingness of government to make large investment in port infrastructures and superstructures. Financial deficit and improper understanding of port project and inapt port management system have been found responsible factors for causing financial risk with high consequence. Nowadays fierce inter-port competition between ports operated by public entity and ports operated under landlord port model cause competition high that makes public port much less effective. Consequently, it may increase financial risk for the port operated by public entity in respect of underutilization of port facilities. Following factors can be responsible for financial risk in the service port model Funding method: Government undertakes the responsibility to invest in infrastructures and cargo-handling equipments. Proper investment with timely manner might make port activities more effective. However, poor government policy for funding leads to wasteful resource or under-investment. Institutional framework: It refers to administrative structure of port operation. In the service port model, port administrative structure generally is in form of vertical connection from central government to port authority. Working approach of port authority: It refers to working hours, tariff, and infrastructure capacity etc. Commercial risk - continuous decrease in port throughput due to high degree of price variability - is closely related to trade flow to and from region via port. It has been found with high degree of serious impact on port throughput because of poor management of port by state or public authority and unresponsive approach to customers need. Overlapping of responsibilities between different departments, high political intervention with regard to investment and operational decisions and inability of government to make efficient investment in port facilities are primary factors of poor port management, which cause high commercial risk. In addition, a number of serious problems - lack of transport infrastructure, high cost of port and landside transport service, time - consuming custom procedure, inefficiencies in transport service- have been found in public owned port. These problems are very often caused by laws and regulation inducing high port tariff and labor cost, absence of competition, and complex bureaucracy. These problems have led to inefficiency of port services. For example Inadequate hinterland connections with public ports is caused either by poor transport infrastructure i.e. Africa, India, Philippines or by government policy i.e. Indonesia and Malaysia. Port of Chennai, India and port of manila, Indonesia (before becoming landlord ports) failed to achieve expected traffic level because they did not address the problem of

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congested access and poor hinterland connections during the project appraisal20. Competition is less among public owned ports within a country, but, it can be high when private sector operates neighboring port within a country and neighboring countries. The port has thus become more costly and lost market share in competitive environment. However in the past some ports were operated very efficiently. For example Singapore port was one of the successful ports operated under service port model before 1997. Country risk can not be characterized specifically in any port model. It entirely depends on location of port (in which country port is located). However, country risk has relatively intermediate impact on port activities, as port has been operated by state or public entity. Herein below legal, political and economical risks falling under the country risk have been explained in terms of their impact on port activities. Legal risk: one of the common reasons for legal risk is lack of precision in legislation and regulation that creates misinterpretation. Legal issues are extremely complex not only because of variety of interpretation but also in terms of jurisprudence (World Bank, 2001). However, in public port where government itself makes investment, laws and regulation are clearly defined and applied. Therefore legal risk is not likely to be raised. Also possibility of changes in existing law cannot influence port activities as government makes changes in law with considering positive resulting impact on port. Therefore legal risk has somewhat low impact on port activities in service port model. Political Risk: political risk is always one of the foremost risks having serious impact on port activities regardless of types of port model. It associates with political instability, government expropriation, regulation imposed inefficiency. In public port, government or port authority owns, controls, and manages land, infrastructures and superstructures, and make a decision about port operation. It thus clearly shows that political intrusion in port management or political instability influence public owned port. Also, regulation related to custom procedure has impeded the reliability of port activities. Political risk is relatively higher in service port model. Economic al risk: The main objective of public port is to support regional development rather than financial return. The throughput of port relies to great extent on macro-economic factors. Thus any change in macro-economic factors has major impact on port operation. Economic al risk may also affect p ort operation by generating other risks i.e. monetary risk, financial risk and commercial risk. The probability of economical risk can be different from country to country for instance economic al risk in developed countries might be lower than that of in developing countries. Abovementioned risks generate the country risk with high or low consequences. Political and economic risks are the most accountable for failure of port activities in developing as well as developed countries.

20

Port sector report two, Asian Development Bank

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Monetary risk can be generated from unexpected adverse movement in the interest rate and exchange rate. It also depends on the duration of investment (short term or long term).The potential for unfavorable changes in economical and political structure might be high in developing country compare to developed country. Thus, we can somehow form an opinion that this risk is high in developing country and moderate or low in developed country on the basis of economical and political condition. Operating risk results from lower traffic level and excess operating cost. Following factors are responsible in public owned port for operating risk: Institutional complexity: In public owned port, more than one public entity engages with port operation. Institutional formation is accompanied b y overlapping responsibilities, centralized bureaucratic management, corrupted problem etc. Under estimation of operating cost during project appraisal: where port is funded from public fund, investment decision is totally based on economic goal rather than financial return. Consequently, major factors affecting operating cost are not always quantified accurately in project appraisal. Fiscal scarcity: Inadequate investment in port infrastructures and superstructures make port operation ineffective and thus reduce traffic level. Obsolete equipments have been used for very long time for handling high volume of cargo. Environmental and safety concerns become extremely important issue for port activities. Different international laws force on government and p authority to ort implement environmental and safety regulation, and make available appropriate facilities. In both developing and developed countries, environmental risk is high.
Table 12: Risk factors in the service port model Ri sk category Risk factors

Construction risk Social risk Financial risk Commercial risk Country risk Monetary risk Operating risk

Environmental risk

-Inadequate and insufficient investment from government -Lack of understanding of port project in terms of technical aspects -Outdated, unreliable and inefficient labor force -Sociopolitical labor law -Inability of government in terms of proper investment -Inapt port management and complex institutional framework -Poor management and unresponsive approach to customers need -Overlapping of responsibilities, high cost of port and landside transport services -High political instability, national legal law and economic situation of country -Inflation rate, fluctuation in interest rate and exchange rate -Non-convertibility of local currency -Under estimation of operational cost -Obsolete equipments -International laws and regulation for environmental conditions -Dredging and filling of open water area
Source: elaborated by author

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5.3
5.3.1

Case Study-The port of Latakia, Syria


(Service port model) Geographical location

The Syria Arab Republic or Syria is located in an area known as Middle East or Southwest Asia. Neighboring countries of Syria are Turkey to the north, Iraq to the east, Jordan to the south, Israel and Lebanon on the west. Syria has two commercial ports the port of Latakia and Tartus port 21.

Figure 8: The port of Latakia

The port of Latakia is one of the ancient ports of Middle East situated at the eastern edge of Mediterranean Sea. It was developed during the Phoenicians, Grecians, and Romans rule. Due to its geographical location the port of Latakia plays a significant role in economic development of Syria. It serves the cargo coming from Europe, the black sea and Mediterranean for the Syria and neighboring gulf countries i.e. Iraq and Iran. It links with a railway of 2342 km long and road networks connecting all major cities of Syria and neighboring countries. 5.3.2 Port governance structure

The port of Latakia is operated by Latakia General Port Company (LGPC). It is a maritime public owned Service Company attached with Transport Ministry of the Syria Arab Republic. Ministry of Transport deals with the management of land, air and maritime transportation. Latakia General Port Company is responsible for investing in port facilities with Ministry of Transport, providing cargo-handling
21

All information regarding Port of Latakia is derived from Port of Latakia website www.lattakiaport.com and Ministry of Transport of Syria Arab Republic website www.mot.gov.sy.

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services and other operational activities such as pilotage, tying etc, employing labor for different port activities, and providing all necessary services for storage of cargo.
Table 13: Distribution of responsibities of port activities in the port of Latakia Functions Elements Responsibility Investment in basic and operational infrastructures -construction, completion and development of new port area and cargo terminal -upgrade of general road and rail infrastructures link to port -development and control of railway from the point of entrance into the port -erection and operational of navigational light and buoys Investment in superstructures -construction and development of port offices, workshop, training facilities, warehouses, transit shed etc -purchase of new tugboats and cargo-handling equipments i.e. new gantry cranes, RTG, Reach Stacker, Prime Mover etc -repair & maintenance of superstructures and equipments infrastructures, LGPC

Ministry of Transport Ministry of Transport & LGPC LGPC LGPC

Investment in equipments

LGPC

Port maintenance

LGPC

Port Services Port safety, security and environment issues

-Cargo-handling and other operational services - environmental policy

LGPC General Directorate of Ports

Provision for labor -Employment of labors LGPC force Source: elaborated by author using MEL Thesis private sector financing of container terminal infrastructure

Above table shows that major responsibilities of port functions are assigned to Latakia General Port Company. Ministry of Transport makes the investment in port facilities while LGPC performs operational activities. There are 2614 labors working under different departments employed by LGPC for port activities. LGPC provides all facilities including training, medical, and others to workers for social welfare. 5.3.3 Risk Management

The port of Latakia is operated under service port model. Ministry of Transport and Port Company deal with port investment, operational and regulatory activities. Thus LGPC is entirely responsible for all risks. How risks are allocated to different parties is seen in the below table.
Table 14: Risk allocation & mitigation in the port of Latakia

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Risk Category LGPC

Risk Allocation Contractor Ministry of Transport Lenders Private Sectors

Risk Mitigation

Construction risk

-LGPC and Ministry of Transport make the contract with construction companies and dredging companies for construction of port facilities i.e. Greek company undertook the 22 dredging project . -LGPC employs labor with different specialization to particular task & provides training them -LGPC makes investment in port facilities therefore there is no any particular risk guarantee from government -LGPC adopts a new tariff policy reducing 25% of current port tariff. -Government does not provides political and economic risk guarantees to LGPC -LGPC does not apply any type of method 23 to minimize this risk -LGPC does not take any kind of step to 24 minimize this risk -LGPC and General Directorate of Ports together make environmental policy

Social risk

Financial risk

Commercial risk

Country risk

Monetary risk

Operating risk

Environmental risk

Source: elaborated by author

From the above table it can be observed that nearly all risks are allocated to Latakia Port Company because the port is operated under service port model that generally imposes risks to port authority. In the previous chapter it is clearly described that every risk must be allocated according to party best able to assess, control and manage risk for the success of port. But in the port of Latakia, LGPC bears all risks regardless of whether it is able to assess, control and manage them at best way or not.
22 23

http.// Damascus.usembassy.gov/ccg2.html Poor development of capital market and countrys lack of access to international money and capital market, and less effective new law still make the fluctuation of exchange rate very high (http.//en.wikipedia.org/wki/Economy_of_Syria) 24 No specific method for port operation has been found by Author so it is assumed that LGPC does not apply specific method for operating risk.

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Even if one party bears all risks; port can be operated efficiently based on how risks are mitigated by the party. In the port of Latakia, no major steps have been taken by LGPC to mitigate or minimize any kind of risks. Financial risk remains with utmost high consequences and occurrence, as LGPC depends entirely on public budget (public budget is very limited for port facilities in Syria) for investment in port infrastructures and port facilities. Government has talked about upgrading and construction of infrastructures and equipments of port of Latakia, but no initial steps in this regard have yet taken place. Consequently, it reduces port efficiency a nd increases waiting time for vessel. A countrys old-fashioned socialist command economy brings about political conflict and instability, and falling economic growth that intensify country risk (political and economic risks) and monetary risk. But neither LGPC nor government has made any kind of appropriate arrangements against these risks. Port links with major cities of Syria and neighboring countries through rail and road networks. Current condition of rail and road networks are in need of upgrading and rehabilitate works but due to inability of government to finance infrastructures the road and rail networks remain in poor condition. Thus inadequate infrastructures, obsolete equipments and outdated technological base result in under-utilization of port facilities that increases commercial risk and operating risks. Lack of transparency and accountability of port management increases social risk. Considering above risk allocation and mitigation system it is clear that the way the port of Latakia is operated is indeed inefficient and under developed. It is to be noted that risk allocation and mitigation have not been applied the right way in port of Latakia. Consequently, the issues of major concern that have been found so far in port are poor infrastructures and superstructures including road and rail networks, obsolete equipments, governments inability of investment in new port facilities, lack of political establishment and development of economic reform in country. As far as port tariff is concerned LGPC reduced port tariff by 25% of current price to make the port competitive with neighboring ports. Despite this effort, port is not able to serve customers very efficiently. The reason behind this is congestion that increases the vessel waiting time at t e port. Shippers still avoid calling to Latakia port due to h outdated and inefficient equipments and cargo-handling services 25.

What lesson can be learnt?


The entire discussion in respect of risks and risk factors in service port model and case study of port of Latakia shows poor management and unresponsive approach of public port authority towards customer needs. I adequate public budget, socion political labor law, high political instability and overlapping responsibilities cause risks with high possibility of occurrence and profound consequence on port competitiveness. The poor and ignored approach of public port authority and government towards risks assessment, risk allocation and mitigation make the port inefficient and experience under-utilization of port facilities.

25

http.// Damascus.usembassy.gov/ccg2.html

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6 6.1

Risk Analysis in the Tool port model Introduction

The tool port model focus es on the public interest and its primary objective is to improve the economic condition of nation by providing port service at lowest cost to society and to generate reasonable return for cargo-handling firms. Both tool and service port models have the similarities in terms of public orientation and the way the port is financed (Mary Brooks, 2004). However, in the tool port model, cargohandling activities are leased to private firms for short time (5-10 years). For that reason, contract should allow reasonable return to private operator on their investment. Risk factors are more or less the same as that of the service port model. But as private sector takes part in operating function, port authority does not entirely bear all risks. This chapter describes the risk and risk factors in the tool port model, and case study of the port of Shahid Rajaie, Iran to understand how risk allocation and mitigation processes are carried out.

6.2

Risk and Risk factors in the tool port model

The way the port is financed in the tool port model is the same as in the service port model. Government takes the responsibility of investment in port facilities so construction risk is entirely allocated to port authority. Inability and unwillingness of government might delay the construction work of port infrastructure facilities. In some ports operated under tool port model, it has been found that port authority has allowed to private sector to install their own cargo handling equipment I.e. gantry crane, but at this point it is no longer a true tool port. Management system always leads to increase social risk for both port authority and terminal operating firms in tool port model. Usually, private operators are not allowed to apply their own workforce. They have to employ labor force from dock unions and pay the rates determined by Dock Labor Board. Also, the labor force is unskilled and creates inefficient port productivity. These create essential problems for port authority and private firms. When port authority allows private operators to make investment in cargo-handling equipments, private operators usually prefer their own workforce to maintain and operate equipment. As result, it l ads conflict between e dock unions and private operators. Finally we can say that the high or low impact of social risk on the port authority and private sector relies on the rules and regulation upon which port authority, dock union and private firms have agreed regarding operational functions. Government or/and port authority undertake the responsibility of financial arrangement for the port infrastructures, superstructures and equipments in tool port model. It is same as in the service port model therefore financial risk and responsible risk factors are relatively same for port authority or government in tool port model and service port model. When private cargo-handling firms are allowed to install their own handling equipments on the terminal site financial risk is increased for the private sector. In the case of private cargo-handling firms financial

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risk refers to loss or lower rate of return or/and loss of investment made in cargohandling equipments In the tool port modal, construction risk, operating risk, and social risks cause commercial risk. Internal factors responsible for commercial risk can be: Funding method: it refers to ability of port authority to install efficient infrastructure and superstructure. In tool port and service port model government makes investment in port project. Indefinite operational responsibilities: indefinite operational responsibilities among private cargo-handling firms and port authority cause the likelihood and impact of risks high. Regulatory risk and commercial risk can be increased due to inappropriate division of tasks. Co-operation between public and private port activities: in tool port model private firms operate only cargo-handling activities on board vessel as well as on the apron and on the quay while other activities are operated by port authority staff. Sometimes conflict can be generated from such management system that might result in higher operational, social and commercial risks. Therefore all port activities need to be co-operated at such a way that reduce likelihood of risks. Ability of private sector to provide efficient cargo-handling system: even though, private firms do not have full control on cargo-handling activities, their ability to provide efficient service with co-operation of port authority staff to ship owner or /and cargo owner improve port efficiency. Contractual relationship: contractual relationship between private sector and port authority must be conducive to the improvement of port efficiency. External factors are almost the same for each port model. They encompass inter and intra-port competition, location of port, hinterland connection and proximity to industrial and consumer areas. Country risk can be considered as external risk which can not be raised from port operation and management functions. It has the same consequences on tool port modal as on service port model. Political stability, economic growth of country and appropriate legal procedure reduce country risk. It would better for private cargohandling firms to take political and economic risks guarantee from port authority or government for the specific period of lease agreement. Port authority and Private cargo-handling firms bear the monetary risk due to inflation rate, exchange rate fluctuation and non-convertibility of local currency. Monetary risk can hedge by swap contract. Factors for monetary risk are the same for each port model. Private firms may also receives guarantees from government against this risk

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Operating risk is very often based upon the way the contractual arrangement (the allocation of operational responsibilities) is carried out between port authority and terminal operating companies for cargo-handling activities. Conflict is generated among port authority, dock unions and terminal operating companies in respect of workforce arrangement. Traditionally, port authority rents out cargo handling equipment to private operator and provides maintenance team. However, as terminal operating company makes investment in equipments, it would seek to control the operating activities with their own dedicated workforce and/or contract out service to other parties for international best practice26. Consequently, it leads conflict between port authority staff and terminal operators that reduce port efficiency and increase operating risk. In the case of the port authority, underestimation of operating cost, lack of freedom to make decision regarding investment, and obsolete equipments are fundamental factors for operating risk. While private cargo-handling firms bear operating risks as a result of less control on cargo handling activities and under investment in equipments. Like monetary risk, environmental risk has the same factors for each port model. In tool port model port authority is usually responsible for this risk but private firm may liable if risk can be generated from cargo-handling activities.
Table 15: Risk factors in the tool port model

Risk category Construction risk Social risk Financial risk Commercial risk Country risk Monetary risk Operating risk Environmental risk

Risk factors -Inadequate and insufficient investment from government -Lack of understanding of port project in terms of technical aspects -Conflict among port authority, labor union and private firms raised for workforce arrangement - Outdated, unreliable and inefficient labor force -Inability of government in terms of proper investment -Inapt port management and complex institutional framework -Co-operation between port authority and private cargo-handling firms -Inability of private firm to carry out efficient cargo-handling functions -High political instability, national legal law and economic situation of country -Inflation rate, fluctuation in interest rate and exchange rate -Non-convertibility of local currency -Indefinite operational responsibilities between port authority and private cargohandling firms -International laws and regulation for environmental conditions -Dredging and filling of open water area
Source: elaboration by author

26

Page 7, World cargo news, June 2004, www.worldcargonews.com

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6.3
6.3.1

Case study- The port of Shahid Rajaie , Iran


(Tool port model) Geographical location

The Port of Shahid Rajaie having an exceptional geographical location with modern equipments and facilities is one of the most important ports of Iran. It is located at the entrance to the Persian Gulf, at the strait of Hormoz and north of Qeshem Island, at southern part of Iran 27. It is one of the huge ports complex situated 20 km west of the Bandar Abbas city. It is well connected with rail and road network to Tehran, the capital and biggest city of Iran, and other cities of Iran as well as neighboring landlocked countries.

Figure 9: The port of Shahid Rajaie

The port of Shahid Rajaie occupies a 55% share of the commercial transaction of Iran through sea. It is considered to be the economical gateway in the field of sea transportation within Middle East and the CIS countries because of ideal geographical location at Persian Gulf and international national rail-road connection with Azerbaijan, Turkmenistan, and Turkey. 6.3.2 Port governance structures

Currently, Shahid Rajaie port is operated under the tool - landlord port model. It is going toward landlord port model. Here it is consider as operated under tool port
27

www.pso.ir/old/rajaie/pages/fprofabbas.htm

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model. Port is governed through Ports & Shipping Organization of Iran (PSO). PSO is part of the Ministry of Roads and Transportation and all ports of Iran are under the control of the PSO. the primary objectives of PSO are to own, develop and maintain port basic and operational infrastructures, port superstructures and port equipments in all ports, to prepare, formulate and enforce port, maritime and shipping regulation considering respective laws, to administrate loading, discharging and handling cargo in port as well as warehousing areas, to secure safety of maritime surroundings and perform the functions according to Iranian maritime law, to collect port dues for loading, warehousing and other port activities. Ports are financed largely from the port revenues and funds received from governments. In the port of Shahid Rajaie, PSO constructs, develops and maintains port facilities. PSO contracts out cargo-handling service of container no.1 to private cargohandling firm named Tidewater Middle East Marine Services for short term contract. It allows Tidewater to use its own equipments such as RTG, Reach Stacker, Prime Mover, Terminal Tractor etc at Shahid Rajaie Port. Tidewater is also allowed to employ its own labor force working at dock side.
Table 16: Distribution of responsibility of port activities in the port of Shahid Rajaie Functions Investment in basic and operational infrastructures Elements -construction, completion and development of new port area and cargo terminal -upgrade of general road and rail infrastructures link to port -development and control of railway from the point of entrance into the port -erection and operational of navigational light and buoys - navigation developing and maintenance Investment in superstructures Investment in equipments - construction and development of port offices, workshop, training facilities, warehouses, transit shed etc -purchase of new tugboats, new gantry cranes etc -purchase of cargo-handling equipments i.e. RTG, Reach Stacker, Prime Mover etc -repair of infrastructures, superstructures and equipments - Cargo-handling services - Other services Responsibility PSO

Ministry of Road & Transportation PSO

PSO PSO PSO

PSO PSO & Tidewater PSO & Tidewater Tidewater PSO

Port maintenance Port Services

Port safety, - environmental policy PSO security and environmental and social life Provision for labor - employment of labor force and other PSO & Tidewater force activities related to labor force Source: elaborated by author using MEL Thesis private sector financing of container terminal infrastructure

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6.3.3

Risk Management

As port is operated under the tool port model, port authority allocates some of the risks with private cargo-handling firms. How each risk is allocated and mitigated is explained in the following table.
Table 17: Risk allocation and mitigation in the port of Shahid Rajaie Risk category Risk allocation Risk mitigation Contractors

Ministry of Transport

Tidewater

Construction risk

Lenders PSO usually makes the performance basis contract with construction and dredging companies for construction of port infrastructures and superstructures. PSO employs personals administrative works. only for Tidewater hires labor force based on contract with some private companies that provides labor for cargo-handling activities however labor are protected by Ministry of Labor. PSO is the part of Government so it dose not take political or economic risks guarantees from government. Tidewater invests only some of the cargohanding equipments without taking particular guarantees from PSO as well as from government. PSO makes the short term contract with private cargo-handling firms with specific payment of amount but fully responsible for under-utilization of port infrastructures and superstructures. Tidewater makes market studies and receives users commitments, no particular method can be adopted Tidewater does not have political or economic risk guarantees from PSO and government. PSO and Tidewater do not take particular steps for this risk No particular technique has been applied by PSO and tidewater for operating risk PSO enforces environmental policy according to international standard Source: elaborated by author

PSO

Social risk

Financial risk

Commercial risk

Country risk

Monetary risk Operating risk

Environmental risk

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Above table provides an overview of risk allocation and mitigation between PSO and Tidewater working in container terminal no.1 of the port of Shahid Rajaie, Iran. The way the business is conducted; it needs to take into account the contractual relationship between PSO and Tidewater for cargo-handling activities, and the funding arrangement of port facilities for the understanding of risk allocation. Tidewater carries out only cargo-handling activities while other port activities are vested with PSO. Workforce is employed by Tidewater for cargo-handling activities. PSO allows Tidewater to install some of the cargo handling equipments. Besides specific payment of amount of lease, Tidewater is also obliged to pay specific part of cargo-handling fees to PSO. As far as risks are concerned, constructions risk, commercial risk, financial risk and environmental risk are entirely or mostly allocated to PSO. While Tidewater is affected by the country risk, monetary risk, operating risk, commercial risk, social risk and somewhat financial risk. Tidewater is subject to political instability, changes in regulatory requirements, economic condition, port tariff, price or exchange controls. The strategy adopted by PSO for construction risk is recommended as it contracts out construction job of port facilities including dredging activities to qualified companies based on performance guarantee. But the approach to risk allocation with regard to commercial and financial risks overlooks to great extent both risks. In the case of commercial risk, PSO rents out cargo-handling activities to Tidewater on short-term basis for providing efficient service but no further particular practices are applied to reduce this risk. Therefore it might have a material negative impact on port business, operational result and financial condition. Considering requirement of heavy investment in port infrastructures and superstructures, it has shown in present era that risk arising from investment (financial risk) in port facilities needs fair risk sharing among all parties involved in the port activities. But PSO undertakes to make large investment in ports alone complying with heavy regulated government system and policies of ministry of Transport. In 2003, for example PSO invested about $482 million in the infrastructure and superstructure projects which comparing to the 2002 and 2001 shows 230% and 900% growth respectively28. Even though making large investment in port, PSO does not take particular guarantees from government. PSO is responsible for under-utilization of port assets. It shows that financial risk may be increased at utmost level. In addition, future redevelopment of port facilities is always threatened by underinvestment. The business of Tidewater essentially depends upon the tariff policy of PSO and political, economic and regulatory changes in the Iran. Tidewater invests in some of the equipments of cargo-handling equipments without taking particular guarantees from PSO or government. It bears financial risk in this regard. As far as country concern, Iran appears with high political instability and adverse economic condition. PSO and Tidewater are subject to country risk and monetary risk that may affect considerably future earnings. Even though, neither PSO nor Tidewater has taken supportive method to mitigate these risks.
28

Page 1, introduction, Annual report of PSO, 2003.by Ahmed Donyamali, General Director of PSO.Iran

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Risk associated with labor is as considerable as above mentioned risks. PSO hires the personnel only for administrative works. For other activities, PSO makes the contract with various private companies for particular personnel. The major drawback of this system is unskilled, inefficient and outdated labor personnel. Tidewater also follows the same approach- employing workforce on contract basis for cargo-handling activities. Furthermore, PSO and tidewater do not have either any kind of long-term agreement with labor-union for future employment or terms and condition if conflict arises. From the above discussion, it is observed that risk allocation and mitigation approach is not applied appropriately in port of Shahid Rajaie. PSO bears financial risk substantially. Tidewater may experience material adverse effect on future earnings due to country risk and monetary risk. Social risk and operating risk are not allocated appropriately between PSO and Tidewater. 6.3.4 Why port moves from tool to landlord port model?

Iran is considered as one of the most vital transit point for trade (cargo) exchanged among Irans northern neighboring countries, the Middle East, Europe and Far East Asia. The port of Shahid Rajaie is located in the most strategic place of the Persian Gulf and one of the most advanced ports of Iran having potential to serve transit cargo very efficiently. Such outstanding position of the port of Shahid Rajaie may become a major source of income. In order to achieve and serve transit cargo, major steps must be undertaken and implemented to make available superior infrastructural and transit facilities at port. But under the present tool port model, port experiences financial, commercial, operating, and social risks in term of lack of technical know-how, restrictive labor practice, technologically obsolescent infrastructures and equipments. PSO is not able to bear alone heavy cost of investment of the new development plan for transit cargo as well as to manage whole affair with applying current strategy. It might increase extremely financial risk and commercial risk. Government and PSO realize that the present port governance model will not competent to deal with transit trade without private sector involvement in port investment and operational activities. Consequently, government and PSO begin to attract the private sector in the port of Shahid Rajaie. In their new approach, government and PSO create a center attention towards strategic risk allocation and mitigation process that will make sure the private sector secure investment and reasonable return with low risk potential. Under the new policy, commercial risk and operating risk are transferred to private sector while financial risk is shared between PSO and private sector according to ability of private sector to invest in port facilities. Private sector is protected against country risk, financial risk and monetary risk by government guarantees. The features of new policy are as follow 29:
29

Guarantees from any viewpoint for investment (political and economic risks guarantees) No bureaucratic regulations and avoidance from red tape

All features of new policy described above are same as I find in the website of www.iran.ru/eng/free_economic_zones.php.

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Proper employment regulations Offshore banking and non-banking credit practices The legal right of foreign investors are guaranteed in the event of nationalization

Investor trust will only transpire through clear, stable, coordinated and safe institutional arrangement that makes sure the foreign and local investors secure investment. It worth describing that PSO might succeed in bringing about good practice of public-private partnership in the port of Shahid Rajaie, as new policy covers guarantees against major risks raised in port sector.

What lesson can be learnt?


The characteristics of tool port model in terms of risk and risk factor are the same as that of services port model. However port authority shares operating and commercial risk at some extent with private cargo-handling firms. Risk allocation and mitigation strategy is not applied appropriately by port authority and private cargo-handling firm considering case study the port of Shahid Rajaie, Iran. From the result of case study, it has been outlined that port is threatened extreme financial risk and commercial risk in terms of underinvestment and under-utilization of port facilities respectively. It worth noting that movement of Shahid Rajaie port from tool to landlord port model indicate explicitly that private sector involvement become inevitable for financing port facilities and managing whole port affairs effectively in the present era of cutthroat competition.

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7 7.1

Risk Analysis in the Landlord port model Introduction

The landlord port model is the form of partial privatization where private sector takes the responsibilities of operational and investment activities while port authority performs the regulatory activities. The landlord port model introduces the private sector participation in the port domain. Under the concession or lease agreements port authority transfers the responsibilities and right to use port facilities to private sector. Through this agreement each party allocates the risks and reward by providing services or facilities. The effectiveness of PSP under landlord port model depends on the strategic risk assessment, and adequate risk allocation and mitigation between port authority and private sector. The objectives of this chapter are as follow: to define the risk and risk factors in landlord port model to illustrate the different case studies: the port of Maputo, Mozambique under concession agreement, the port of Long Beach, United States under the lease agreement and the port of Xieman, China under the joint ventures, to understand risk allocation and mitigation procedure in the landlord port model

7.2

Risk and risk factors in the landlord port model

In the landlord port model, the majority of risks are assigned to private sector according to contractual agreement for the transfer of responsibilities and right to use port facilities. Project profitability is a crucial precondition for encouraging private sector in port sector. The major risks and risk factors in landlord port model are described as follow. Construction risk is very often based on the funding arrangement between port authority or government and private sector. Under the concession agreement, private sectors including merchant banks take the responsibities to invest in port operational, superstructures and equipments while port authority invest in port basic infrastructures. In this regard, construction risk can be caused due to inability of private sector as well as port authority to finance the port facilities. In some of the lease agreement port authority builds all port facilities and lease them to private sector in this case construction risk arises from the port authority approach towards investment in port facilities. Furthermore, other factors for construction risk are error in project design and poor management to accomplish construction job within specified time. The success of any enterprise depends on the performance and skill set labor force. Social risk relating to labors participation in port activities can be considerable. Port authority and private sector need to negotiate the wages, salaries and other benefit with labor force and maintain good relationship with labor union for providing good quality service. Failure of satisfied negotiation with labor force could adversely affect the efficiency of port operation. Private sector bears this risk in terms of

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retrenchment payments, pension liabilities and retraining etc. Sometimes government is obliged to pay retrenchment payment and pension liabilities. Problems arising from the agreement of future employment can be the particular concern of the private sector because such problems affect directly on port service and facilities and as a result private sector may loose essential customers. The major factors for social risk are inefficient, unskilled and aged workforces, strong unionism, overstaffing etc. It would be necessary for successful public-private partnership that port authority and private sector assume responsibilities for the future problems relating to labor force. The risk of lower rate of return or/and loss of investment can be substantial for port authority and private sector. Financial risk concerns the changes in payment of loan or/and income arising from port services. Actual past performance and current condition of port can not give the guarantee of future results. Failure to continue an effective port management and operation system could lead to financial loss. Financial risk is subject to wide range of internal and external factors that impact on business strategy and operational result. The primary internal factor is partnership or contractual relationship between port authority and private sector. It could impair the financial and operational performance of port. Commercial risk is completely transferred to private sector in public-private partnership under the landlord port model. Most of the port business depends on continued growth of international trade. Private sectors are affected by the global market condition, growing inter and intra port competition, hinterland connectivity with port, tariff and quality of service etc. Private sector is subject to political, economic and regulatory changes in the country where port is located. Country risk could have a negative impact on the current and future earnings, financial condition, and operational result. The major risk factors for country risk are volatility in GDP, political instability, adverse economic condition, government policies, and countrys competitiveness in international market. As explained in previous chapter that the factors responsible for monetary risk are the same in each port model. Monetary risk creates the earning volatility through exchange rate and interest rate fluctuation. Operating risk is assigned entirely to private sector in landlord port model. It results from the overrun operating cost and low-level of port throughput. Lower technical standard and lack of proper maintenance of equipments can be additional factors for operating risk. In the recent years, environmental concerns and liability provision of various international and national laws and regulations have indeed imposed barriers to placing port sector outside from common industries that experience extensive consequence of environmental risk on business. Environmental risk factors as explained earlier are dredging, bunkering activities, habitat loss and dredging disposal.

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Table 18: Risk factors in the landlord port model Risk category Risk factors

Construction risk Social risk Financial risk Commercial risk Country risk Monetary risk Operating risk

-Inability of private sector as well as public authority to finance construction works -Inadequate assessment of project design and poor management task -Failure of satisfied negotiation in terms of wages, working time and condition. -Outdated, unreliable and inefficient labor force -Changes in the amount of loan -In effective port management system and other external factors -Growing inter and intra port competition, and hinterland connectivity with port -Tariff and quality of service, global market condition -Political, economic and regulatory changes in the country -Countrys competitiveness in international market. -Inflation rate, fluctuation in interest rate and exchange rate -Non-convertibility of local currency -Lower technical standard and lack of proper maintenance of equipments

Environmental risk -International laws and regulation for environmental conditions -Dredging and filling of open water area

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7.3
7.3.1

Case study-The port of Maputo, Mozambique


(Concession agreement for whole port under the BOT scheme)

Geographical location

The port of Maputo is one of the most important southeastern Africans transit port, located in the southern part of Mozambique, on the east coast of Africa. The port of Maputo has the ideally geographical location to serve cargos from or to the southern Mozambique and the neighboring countriesthe northern and eastern parts of South Africa, Swaziland, southern Zimbabwe, Botswana, and Zambia. It is the largest port of Mozambique having substantial consequence on and provides an impetus for, the economic growth of Mozambique. The port of Maputo handled around 17 million tones of cargo each year before the civil war in Mozambique that began in 1975. But it was reduced up to couple of million tones due to this war30.
Figure 10: The port of Maputo

7.3.2

Port governance structure

At the end of the 1990s, the government of Mozambique finalized to introduce private finance in port sector. Consequently, port of Maputo has been handed out to private sector with responsibility of finance and port operation in April 2003. This might be the first port project in Africa based on the Public- Private Partnership (PPP) method. Port of Maputo has been approved to MPDC (Maputo Port Development Company) for 15 years concession with a 10 year extension option in 2003. The Maputo Port Development Company has been awarded the concession under BOT arrangement to manage the port of Maputo with powers (legal as well as operational control) of port authority and responsible for marine operations,
30

All information regarding Port of Maputo is received from website www.portmaputo.com and www. finnfund.fi/ajankohtaista/arkisto04/en_GB/Maputo.

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stevedoring, towage, pilotage, terminal and warehousing operations, and port planning and development. Government has also granted the right to finance, rehabilitate, operate, maintain, and develop the port concession area. However all physical assets remain with the government of Mozambique. MPDC is private company registered in Mozambique and is owned as to 51% of equity by international investor consortium and other 49% of equity by Mozambican partners. International consortium consists of The Mersey Dock and Harbor Company, the UK largest port group, Skanska BOT AB of Sweden and Liscont Operadores de Contentors, S.A. of Portugal. Mozambican partners include Portos e Caminhos de Ferro de Mocambique (Mozambique ports and railway company) (CFM) and the government of Mozambique. CFM is responsible for supervising concession of port and railways facilities of port of Maputo. MPDC
International Consortium The Mercy Dock (18.3%) Skanska (16.3%) Liscont (14.8%) Figure 11: Shareholders of the MPDC CFM (33%) Govt. of Mozambique (16%) Mozambican Partners

MPDC makes the investment in port facilities by the private stack holders own resources and by lending i ternational merchant banks- Merchant Bank of South n Africa, Standard Corporate, Development bank of South Africa, the development finance companies of the Netherlands and Sweden, FMO and Swedfund, the Nordic Development Fund NDF. Finnfund provides the mezzanine finance worth 3 million US dollars. The approximately budget for rehabilitation program is US$ 70 millions. Immediate priorities have been given to dredging of the harbor and approach channels, drainage improvement, repair and re-construction of internal road and rail networks, warehouses, cargo-handling equipments, vehicles, mobile harbor cranes, and computer system.

Figure 12: The N4 Highway linking Johannesburg and Maputo

The port of Maputo serves transit cargo at large scale therefore hinterland connection is quite important for development and competitiveness of port of Maputo. If we look at the inland transport facilities, Maputo has adequate rail and road connectivity. New road and rail network links make Maputo more competitive in

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serving the transit traffic of highly productive and industrial areas of northern part of the South Africa. South African importers and exporters are considered to be the biggest customers of port of Maputo. The new N4 Highway linking Maputo and Johannesburg creates shortest transit route for the northern largest exporting regions of the South Africa and the neighboring countries to directly the port of Maputo. The port of Maputo has more than five different cargo-handling terminals that are sub-leased by MPDC to different private cargo-handling companies. Container terminal is operated by MIPS (Mozambique International Port Services), Citrus terminal is by MPT (Mozambique Produce Terminal), Bulk sugar terminal is by STAM (Sociedade Terminal De Acucar De Maputo), Molasses terminal is by CEML (Companhia Exportadora De Melacos), Coastal terminal is by TCM (Terminal De Cabotagem De Maputo), and Bagged sugar is by ED+F Man Mocambique LDA.
Table 19: Distribution of responsibilities of port activities in the port of Maputo Functions Elements Responsibility Investment in basic and operational infrastructures - dredging of access channel & inner harbor - design & construction of new cargo terminal - upgrade of general road and rail infrastructures link to port - construction of new road in port area linking directly onto the N4 highway Investment in superstructures Investment in equipments Port maintenance - rehabilitate of port offices, workshop, training facilities, warehouses, transit shed etc -purchase of new tugboats, new cranes, and other material handling equipments -repair of infrastructures, superstructures and equipments - Cargo-handling services -other services - environmental policy MPDC MPDC Govt. of Mozambique MPDC & CFM

MPDC

MPDC

MPDC

Port Services

Port safety, security and environmental and social life Provision for labor force

Cargo-handling firms MPDC MPDC

- employment of labor force and other activities MPDC & CFM related to labor force Source: elaborated by author

7.3.3

Risk Management

Usually, successful port project under the BOT rests on the project finance structures and concession agreement. Risk identification in project and then analysis, allocation and mitigation of risk are the essentials of port project financing. How risks are allocated and mitigated in port of Maputo is explained below tables.

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Table 20: Risk allocation and mitigation in the port of Maputo Risk category Risk allocation Risk mitigation Cargo-hand firms Contractors Merchant banks -MPDC makes subcontract with Dredging International Group for dredging of the port access channel. It also makes the construction management contract with Skanska BOT to refurbish the port under a period of three years. For construction program of port MPDC received the commercial loan from Merchant banks with a guarantee. -Government makes concession contract with TRAC for building, operating and maintaining the N4 highway. In the case rail link, Govt. makes the concession contract with NLPI together with Spoornet and CFM to build rail link from south African border to port of Maputo for 15 years. - CFM reduced the total staff, estimated at 2000 employees, by 40 per cent prior the introduction of the private sector in port of Maputo. Total $133 millions are allocated from CFM ($13 million), Government ($ 20 millions) and World Bank (100 millions) for redundancy payments and professional reintegration program for 31 workers including port of Maputo . CFM & Govt. MPDC

Construction risk

Social risk

Financial risk

-MPDC received the commercial loan from merchant bank based on the performance guarantee and credit risk guarantee. -Commercial loan provided by Merchant Banks is covered with political risk and economy risk guarantee from government to back up whole loan and by partial risk guarantees from the World Bank 32 Groups Multilateral Investment Guarantee Agency (MIGA) . -MPDC makes the sub-lease agreement with different private cargo-handling firms i.e. MIPS, MPT, CEML, TCM, STAM and ED+FM

Commercial risk

Country risk

Monetary risk

Operating risk Environmental risk

Government provides political and economic risks guarantee to MPDC and Merchant Banks. Also, political risk was covered by MIGA political risk guarantees. The new investment law allows MPDC and cargo-handling firms to hold offshore accounts, repatriate forex, tax holidays and reduction 33 in the level of withholding tax MPDC transfers operating risk to different cargo-handling firms through sub-lease agreement of cargo terminals. MPDC passes environmental risk to contractual contractors and carries out environmental risk assessment and drafting environmental management and monitoring plans etc. Source: Elaborated by author

31 32

Africa ports: reform and the role of the private sector Report by the secretariat of UNCTAD International securitization & structured finance report, May 15, 2003, volume 6, no.9 33 International securitization & structured finance report, May 15, 2003, volume 6, no.9

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Risk allocation and mitigation process involved in implementing the concession agreement of the port of Maputo was always going to be challenging job to fascinate the private sector in port operation and management considering recent history of Mozambique and very few privatized infrastructures in country. Furthermore, lack of complete implementation and proper management of road and rail link between highly productive and industrial areas of northern part of South Africa and port of Maputo was considered to be considerable issue. Concession agreement -drafted and negotiated to be as bankable- emerged as a cornerstone of the transaction between government and private sectors in order to attract the appropriate private investment. The structure of concession agreement helped ensure the effective risk allocation and mitigation among different parties involved in port management and operation. Construction risk is allocated to MPDC for port infrastructures , superstructures including equipments, and Government for construction of general road and rail networks linked to port of Maputo. Both MPDC and government mitigated construction risk at an absolute appropriate way. MPDC awarded contract to Dredging International Group for dredging of the port access channel, and made the construction management contract with Skanska to refurbish the port under a period of three years. Government makes concession contract with TRAC (Trans African Concessions (Pty) Ltd) for building, operating and maintaining the N4 highway. In the case rail link, Govt. makes the concession contract with NLPI (New Limpoo Bridge Project Investment) together with Spoornet and CFM to build rail link from South African border to port of Maputo for 15 years. Social risk was allocated to Government before and during privatization program in port of Maputo. CFM carried out major the job reduction program in collaboration with concessionaires. CFM, Government and World Bank allocated more than US$ 133 million for the implementation of redundancy payments and professional reintegration program for workers. In the port of Maputo 2,000 workers, by 40 per cent prior to the introduction of the private sector were released34. Such a large action of government made concession program more effective for private sectors. In port of Maputo, social risk was mitigated in such a way that private sector are not obliged to negotiate with labor for the cost of labor retrenchment in the future. The way the financial risk was allocated and mitigated in port of Maputo was really exceptional. The challenges of bringing out suitable finance structures were overcome by attracting commercial banks and financial institutions with providing fundamental guarantees. Rehabilitation programs of Port infrastructures and facilities were undertaken by commercial loan consisting senior debt, subordinated and mezzanine debt. This structure makes sure that minimal risks are left to MPDC and lenders (lenders include the development finance institutions, multilateral institutions and commercial local banks) are protected with political risk guarantees to back up the payment of loan. Loan is also being protected by partial risk guarantees from the World Bank Groups Multilateral Investment Guarantee Agency (MIGA).
34

Africa ports: reform and the role of the private sector Report by the secretariat of UNCTAD

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SIDA (Sweden International Development Government Agency) shared the financial risk with Standard Corporate and Merchant Bank in South Africa with performance guarantee and credit risk guarantee from MPDC and political and economic risks guarantee from Government and MIGA political risk guarantee from World Bank. (www.sida.se) According to BOT agreement under the landlord port model, commercial risk is always allocated to private sector. In port Maputo, responsible risk factors for commercial risk were poor road and rail link and inapt port management. Both risk factors were identified by government and MPDC. MPDC took out the management and operation of port and sub-leased terminals to various private cargo-handling firms based on specific payment of lease and, terms and condition for particular period. While Government made the concession agreement with private companies for road and rail link with port of Maputo. Applying this strategy assisted MPDC to mitigate commercial risk as much as low. As far as country is concerned, political instability, recent civil war and poor economic condition of Mozambique remain to pose investment risks that increase the country risk. Country risk is allocated to MPDC and Merchant Banks in terms of port commercial activities and financial responsibility respectively. However, Government provides political and economic risks guarantee to MPDC and Merchant Banks. Also, political risk was covered by MIGA political risk guarantees 35. In the case of the monetary risk, government passed new legislation in investment law to grant a number of fiscal benefits to private sectors. Under the new legislation of Investment law, MPDC and cargo-handling firms are allowed to hold offshore accounts, repatriate 100% capital profit. Tax holidays and reduction in the level of withholding tax have also been introduced.36 MPDC responsible for operating risk transfers this risk to different private cargohandling firms through short term lease agreement for particular cargo-terminal with specific lease amount. MPDC passes environmental risk to contractual contractors and carries out environmental risk assessment and drafting environmental management and monitoring plans etc. Government of Mozambique assessed the value of port of Maputo for development of country and realized that this great asset must be fully utilized. But recent civil war and political instability raised challenges and thus government confronted to the involvement of private sector in port management and operation. The existing challenges were only to be overcome through robust concession agreement. Considering this condition government drafted and negotiated bankable concession agreement in order to attract private financing. Through bankability of concession agreement minimum risk are left to MPDC, and lenders were willing to provide commercial loan based on political risk guarantees and partial risk guarantees from the MIGA. Off-shore accounts, 100% repatriation of capital and profit, and tax holidays and reduction in the level of withholding tax have also been introduced to
35 36

International securitization & structured finance report, May 15, 2003, volume 6, no.9 International securitization & structured finance report, May 15, 2003, volume 6, no.9

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mitigate country risk and monetary risk. One of the most significant steps taken by government is upgrading of road and rail networks connecting northern area of South Africa to directly port Maputo to reduce commercial risk and financial risk. The risk management process and approach adopted through concession agreement emerged as cornerstone for transaction of port of Maputo. Applying above-mentioned risk allocation and mitigation systems resulted in best outcomes for Private Sector Partnership in port of Maputo. Currently port is operated very successfully and highly efficiently. If we look at the cargo throughput of the port, total volume of goods increased from 4.3 million tons in 2002 to 4.9mt in 2003. Container volumes increased 15% in 2003 (to 40,000 TEUs) and the Fresh Produce Terminal has grown a record 25% increase in throughput of first class fruit over the previous export season (P&S, Feb. 21, 2004 www.ports.co.za). The distance from the major citrus growing region of Limpopo to Durban is 1156km compared with just 450km to Maputo, which exporters estimate savings up to 33 percent in railage costs alone (Terry Huston April, 16, 2004 www.ports.co.za). BMW has publicly stated that Maputo will be an alternative port to more distant SA ports (P&S, Feb. 21, 2004 www.ports.co.za).

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7.4

Case Study-The port of Long Beach, USA (Landlord port model under Lease agreement)
Geographical location

7.4.1

The port of Long Beach is located in the south part of Los Angeles, California on the west coast of United State on Pacific Ocean. It competes with next-door neighbor- the port of Los Angeles. It is one of the worlds busiest container ports and second busiest seaport of United State of America. It ranks 12th in the world in terms of container cargo port37. It is considered to be a leading gateway of untied state for cargos coming from East Asian countries i.e. China, Japan, South Korea and Taiwan. The port of Long Beach provides the facilities to serve containerize, dry bulk, liquid bulk and break bulk & Ro-Ro cargoes.
Figure 13: The port of Long Beach

7.4.2

Port governance structure

The port of Long Beach operated under landlord port model is governed by the Long Beach Board of Harbor Commissioners (LBHC). The Long Beach Board of Harbor Commissioners consist of five members appointed by the Mayor and Confirmed by the City Council. It is managed as Harbor department of the city of Long Beach and known as the port of Long Beach. The Board of Harbor of Commissioners leases a fully equipped terminal including developed land area, ship-to-shore equipments, terminal handling equipments, warehouses, offices, maintenance facilities and gate complex to private companies ( shipping lines and cargo-handling firms) for longterm lease agreement. The shipping terminal leases are the primary source of earnings for the Long Beach Harbor Department. Currently, seven different terminals are developed for containerized cargo, and leased to various shipping lines and cargo-handling firms. One of the terminals named Pier T Berths 130-140 has been leased to TTI/ Hanjin Shipping Co. The port of Long Beach and The Hanjin Shipping have agreed to a 25 year lease agreement for the pier T Terminal. Under the lease agreement, Hanjin operates the ports newest and largest container terminal equipped with a dockside rail yard, 30 lane truck gate complex, and 12 to 16 post-panamax sized cranes. This massive project is a major investment for the port of Long Beach and Hanjin Shipping Company. Hanjin pays a minimum $42 million a year or more than $1
37

All information is derived from wesite of port of Long Beach www.polb.com

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billion during the 25 years of the lease to port Long Beach38. Total Terminals International (TTI) operates the terminal for Hanjin. TTI is the joint venture between Hanjin Shipping Company and Marine Terminals Corporation of San Francisco. TTI also operates the terminal for Hanjin in port of Oakland and port of Seattle. The responsibility of port functions distributed between the Long Beach Harbor Commissioners and TTI are descried in following table. Here TTI is considered to be responsible for port operational activities in behalf of Hanjin Shipping co.
Table 21: Distribution of responsibilities of port activities in the port of Long Beach Functions Elements Responsibility Investment in construction, completion and development of new LBHD basic and port area and cargo terminal operational infrastructures upgrade of general road and rail infrastructures link LBHD, Federal to port and State Governments erection and operational of navigational light and LBHD buoys Dredging of access channel and inner harbor Construction of new road and rail in port area linking directly to the general road and rail infrastructures Investment in superstructures Investment in equipments construction and development of port offices, workshop, warehouses, transit shed etc purchase of ship to shore equipments, terminal handling equipments and other material handling equipments Maintenance of superstructures port infrastructures and LBHD LBHD

LBHD

LBHD

Port maintenance

LBHD

Maintenance of port equipments Port Services Port safety, security and environmental and social life Provision for labor force Cargo-handling services Environmental policy

TTI TTI LBHD

Harbour department employees Long shore workers

LBHD TTI

Source: elaborated by author using MEL Thesis private sector financing of container terminal infrastructure

38

Industry Project, America, Long Beach, www.port-technology.com

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7.4.3 Risk Management


The following table outlines the risk allocation and mitigation process made by Long Beach Harbor Commissioners and Hanjin/TTI under the lease agreement for the terminal T
Table 22: Risk allocation and mitigation in the port of Long Beach Risk category Risk Allocation Risk Mitigation Government Contractors

TTI/Hanjin

Construction risk

Lenders -LBHC awarded dredging and wharf contract to Manson Construction Co. It also make the agreement for construction of terminal building, gate complex, container yard and on-dock rail yard -LBHC purchased the Right-of way rights investing $200 million and sharing cost on a 50-50 basis with Los Angeles Harbor Department for the development of Alameda Corridor -LBHC pays wages to only Harbor Department Employees under the terms and conditions approved by City Council.

Social risk

LBHC

-TTI

Financial risk

makes the contract with Long shore Workers Union to operate shipping activities at terminal -LBHC enters in to lease agreement with Hanjin udder which Hanjin pays $42 millions to port. LBCH also takes the insurances of port facilities against any kind of damages -Hanjin makes contract with shippers and makes the market studies of future consumer demand of area near to port of long beach. -Hanjin makes the agreement with shippers under which shippers book the space with hanjin to move the cargo in USA. It also makes the market studies of future consumer demand of area near to port of long beach. -considering prolonged political stability and continues economic growth, count ry risk itself is very low in US. -As port is located in USA; Hanjin does not face risk of the exchange rate fluctuation, and local currency risk. Hanjin can repatriate capital and profit. Hanjin provides efficient cargo-throughput to terminal that reduces the operation cost overrun. Also TTI offers port services to other reputed shipping lines. -LHBC is extremely conscious with environment issue. Port initiated voluntary ship speed reduction program to lessen emission. It also applied various program for secure environment Source: Elaborated by the author

Commercial risk

Country risk Monetary risk

Operating risk Environmental risk

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Under the lease agreement, LHBC offers fully equipped terminal to private sector thus construction risk is entirely allocated to LHBC. The strategy of LHBC provides the better understanding in achieving risk mitigation in respect of construction risk. LHBC makes the fixed price contract with contractors where by construction company bears the overrun cost. LHBC awarded the $33.6 million dredging and wharf contract to Manson Construction Co. LHBC also awarded contracts for the gate complex, paving facilities and construction of building. Labor practices are a considerable problem in port of Long Beach. Social risk is at utmost high level. LHBC is responsible for only harbor department staff. LHBC does not have a direct connection with long shore workers. The long shore workers are employed by TTI/Hanjin on contract basis. The Pacific Maritime Association, the management group formed by major shipping lines and terminal operators, makes the agreement with Union of long shore workers for shipping activities at terminal site. Not having Intervention of government as well as LHBC in long shore labor matter causes a serious problem for Hanjin. Thus Labor practices remain a serious question for shipping lines and terminal operator including TTI/Hanjin working in US ports. LHBC bears the financial risk at large scale as it makes the whole investment in port facilities. LHBC issues various kinds of Bonds secured by the department gross revenues to pay for the redesign and expansion of the container cargo terminal. The lease agreement with Hanjin, under which port receives $42 million every year or more than $1 billion in 25 years, reduces the possibility of occurrence of financial risk with considerable consequences. The department currently carries extended coverage insurances for port infrastructures, superstructures and equipments against loss or damages generated due to other risks. Hanjin seeks to minimize financial risk from its side by container slot agreement with shippers to ship large scale of the cargo import to USA. Having pre-defined agreements with shippers - large department stores, retailers, manufactures (Wal-mart, Target, US exporters) with regard to container slots booking, Hanjin can easily mitigate or lessen commercial risk. It is more costeffective for shippers to bring cargo to Long Beach and transport via rail than ship cargo through Panama Canal. Making contracts with major United States and Canadian rail companies, Hanjin provides the on-dock premier intermodal services from Long Beach to major cities of the North America. Furthermore, comprehensive involvement of LHBC in respect of road and rail network connectivity with port supports the increasing cargo. LBHC purchased the Right-ofway rights, sharing cost on a 50-50 basis with Los Angeles Harbor Department for the development of Alameda Corridor considering a comprehensive transportation corridor between port of Long Beach and central area of Los Angeles. This corridor could take a substantial number of trucks off the highways and decreases the congestion from road side and secures the efficient and competitive service to and from the port. Hanjin shipping is less subject to country risk. Considering prolonged political stability and continues economic growth, we may assume the probability of phenomenon of country risk is very low in the US. Responsible sources of monetary risk i.e. exchange rate fluctuations and nonconvertibility of local currency, are not arising in the case of port of Long Beach.

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Usually shipping lines and terminal operators collect the revenues from shippers in US dollars. They need to hold an off-shore account, if terminal operators are required to pay off the project debt, amount of lease, operating cost and other expanses in the hard currency of the host country where dollar is not denominated as local currency. Consequently, terminal operators may face exchange rate fluctuation between local currency and dollar. In such case monetary risk can be resulted, but in the case of port of Long Beach located in USA where local currency is denominated in dollar so it never causes exchange rate or convertibility of local currency risk. Thus, Hanjin does not need to hold an off-shore account against the exchange rate risk and local currency risk. Hanjin can also repatriate capital and profit. As far as o perating risk is concerned, Hanjin bears entire risk under the lease agreement. Operating risk arises from lower level of cargo-throughput, operating cost overrun, and loss of income due to non-collection of revenue, fraud from customers etc. Hanjin transfers the operating risk to TTI -a joint venture between Hanjin and Marine Terminals Corporation. TTI is leading provider of terminal operating services in west coast of US. Hanjin minimizes the operating risk arising from lower level of cargo-throughput and fraud from customer by making available efficient cargo traffic and providing fast, safe, secure and reliable port services through TTI to other reputed shipping lines. Operating cost overrun can be mitigated through particular estimation of operating cost. Environmental risk is mitigated very aptly by LBHC. Port is applying various pollution prevention programs to reduce environmental risk. Currently port is working on a $2 million project of reducing emission from trucks, train, and other types of port equipments. In addition, p initiated voluntary ship speed reduction program to ort lessen emis sion. It has also developed an award, winning storm water pollution, prevention program to remove contaminated sediments through dredging. The risk allocation and mitigation approach adopted in port of Long Beach is consistent based on the rule (allocation of risk to the party best able to manage it). Both LHBC and TTI/Hanjin are able to mange risks at best way and thus make the business successful and profitable. The way the construction risk, environmental risk and financial risk are carried out by LHBC ensures the effective and secure fiscal resources and management. However it may be argued that social risk is still not allocated at correct way. It is the major obstacle for current and future growth of port as well as business of terminal operators. Labor problem may continue play a serious role in management and operation of terminal for Hanjin over the life of lease agreement. Port authority or governments involvement in solving restrictive labor practices and problems could lead to increase opportunity to achieve a better risk allocation between LBHC and Hanjin Shipping. As far as commercial risk is concerned, one third of the cargo shipped through the port is consumer goods that are usually manufactured overseas. According to U.S. census, per capita consumer demand has doubled in the last decade. Port Executive Director Richard D. Steinke said We project a doubling or tripling of trade during next two decades considering present growth of consumers demand. As long as consumer demand increase, cargo volumes will also grow with same level

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and that is the primary reason for continue growth of port cargo volumes. Hanjin keeps in mind such influencing factor behind commercial risk and to be aware of the mitigation opportunities i.e. continuing market studies, long- term slot agreement with shippers, and fast, reliable and secure shipping as well as port services. It is to be noted that Hanjin has called Long Beach port since 1979 as a successful shipping lines and its cargo-traffic has continued increased. Having such prolonged experience and relationship with shippers may absolutely reduce or cause lower commercial risk potential. Implementing joint venture strategy with Marine Terminals Corporation for effective terminal operation activities and bringing more and more cargo-traffic at terminal minimize operating risk at great extent. Based on the above discussion, it is worth noting systematic approach to identification, allocation and management of risks between LHBC and Hanjin leads to better understanding of the projects risks and results in desired outcomes that have been seen in the following figure.

Figure 14: Throughput of terminal T, the port of Long Beach Source: www.polb.com

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7.5
7.5.1

Case Study-The port of Xiamen, China


(Landlord port model under the Joint-venture) Geographical location

The port of Xiamen is located at southeast coast of the PRC in the Fujian province at the midpoint along the route between Shanghai and Hong Kong. It is multifunctional and comprehensive port including eight port zones- Dongdu, Haicang, Songyu, Easter Port Zone, Passenger Port Zone, Zhaoyin, Houshi and Shima.

Figure 15: The port of Xiamen

In 2004, it becomes the 7th largest port in China and 26th-largest in the world due to remarkable growth of container throughput 39. It is also one of the pilot ports for direct shipping with Taiwan. 7.5.2 Port governance structure

All ports of China except Qinhuagdao are operated either by the local government or in joint management between MOC (Ministry of Communication)40. New port law 2004 has conveyed the legal responsibility of MOC and Central Government to local municipal Government. Port has autonomy on a number of issues regarding construction, material supply, port planning, labor and remuneration. The port
39 40

www.iss-shipping.com www.cbbc.org

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governance structure of the Chinese ports is administrated under the increasing commercialization trend through the restructuring of port ownership in to public shareholding and the separation of ports regulatory and commercial functions. The port of Xiamen is also governed in the same manner whereby Xiamen Port (Group) Co (XPG) has been established to handle the commercial operations of the port with private (foreign or domestic) sectors while the Xiamen Municipal port authority directs the operators and developers of port facilities. The Xiamen International Container Terminal (XICT) at Haicang has been operated under the joint venture between XPG (35.7%), Xiamen National Trade Company (15.3%) and Hutchison Delta Ports (HDP) (49%) since 1997 41. It is located in the Xiamen Special Economic Zone. HDP is the subsidiary of Hutchison Whampoa Ltd. Considering this joint-venture how responsibilities of port activities are carried out is shown in the below table.
Table 23: Distribution of responsibilities of port activities in the port of Xiamen Functions Elements Responsibility Investment in infrastructures -construction, completion and development of new port area i.e. dredging, soil improvement and land reclamation -upgrade of general road and rail infrastructures link to port -construction of berth -erection and operational of navigational light and buoys -construction and development of port offices, workshop, training facilities, warehouses, transit shed etc -purchase of cargo-handling equipments such as new gantry cranes, RTG, Reach Stacker, Prime Mover etc Cargo-handling services and other operational services Marketing of port location and operation repair of infrastructures, equipments environmental policy superstructures and Xiamen Govt. and MOC

MOR

XICT XICT XICT

Investment in superstructures

Investment in Equipments Port services

XICT

XICT XICT XICT

Port maintenance Port safety, security and environmental and social life Provision for labor force

Xiamen Marine Bureau and Local Govt. XICT

employment of labor force and other activities related to labor force

Source: elaborated by author using MEL Thesis private sector financing of container terminal infrastructure

41

Xiamen port project in the peoples of Republic of China, Asian Development Bank, March 2005

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7.5.3

Risk Management

The risk management process and approach adopted in the port of Xieman is explained through table and comprehensive description. How the major risks are allocated and mitigated in the port of Xieman is shown in following table. In the case of country risk author has applied fact-based assumption to explain risk mitigation strategy.
Table 24: Risk allocation and mitigation in the port of Xieman Risk analysis Risk allocation Risk mitigation

Contractors

lenders

Govt.

XICT

Construction risk

Construction of port infrastructures and other facilities was awarded to various contractors and suppliers under the strict terms and conditions of contracts implemented by ADB XICT can self determine its institutional and personnel system, scale, time, working condition, patterns of recruitment. In addition XICT can dismiss those personnel who remained un qualified Financial support of ADB, Japan Special Fund, MOC and State Development Bank to construction of port basic infrastructures indicates less financial risk for XICT. XICT prepares the financial assessment for future business based on the latest traffic projection and financial parameters XICT applies the cost-effective tariff to enhance the high cargo traffic growth. Port tariff has been reduced by 9% since 2001. Considering positive traffic level, XICT continues implement management reform program and further investing in the state-of art equipments. No specific guarantees from government, however ADB`s involvement and favorable regulations and provisions assist against country risk XICT can open the foreign exchange current account Prolonged experience and skilled technical know-how of HPH minimize operating risk at great extent. XICT also developed Management Information System (MIS) to reduce operating cost Xiamen Marine Bureau and local government carry out various environmental mitigation measures which approved by the National Environmental Protection Agency Source: elaboration of author

Social risk

Financial risk

Commercial risk

Country risk Monetary risk

Operating risk

Environmental risk

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XICT is operated under the Equity joint ventures (EJV) whereby Xieman port Group Company and Hutchison Delta port share each risk mutually. The risk management practice in the port of Xieman produces effective risk allocation among MOC, Xieman Government, Xieman Port Group Company and Hutchison Delta Port. Active involvement of ADB in development of the whole port of Xieman, separation of non operational activities, countrys FDI policy, and favorable legal and institutional restructuring reduce further the occurrence and consequences of risks. The port of Xieman follows the best common practice to minimize the construction risk. Construction of port basic infrastructures and facilities was awarded to various contractors and suppliers under the strict terms and conditions of contracts implemented by ADB. XICT also make the contract for construction of superstructures and other facilities. XICT is granted full right to self determine its institutional and personnel system, scale, time, working condition, patterns of recruitment under the new regulations on labor management. In addition XICT can dismiss those personnel who remained disqualified. XICT usually applies open competition and merit system to employ skilled personnel. A number of favorable factors have been found against the occurrence of commercial risk. Newly dredged channel and turning basin increase the number of larger vessels calling to port. An effective market strategy will hopefully contribute steady traffic growth. Port takes the advantages of direct hinterland connection with Fujian, Guangdong, and Jiangxi provinces. A new railway track enables the port to be linked to these provinces currently witnessing fast economic and foreign trade. The total highway mileage amounted to 54876 kilometers, with a 727-kilometer expressway linking Xiamen to all major cities in the PRC. The road and NTHS networks support the fast socioeconomic development in Fujian Province and facilitate cargo transport from Xiamen port to final destinations. This new integrated transport approach improves port operation significantly (Xiamen port project in the peoples Republic of China, March 2005, ADB, page no.14). Furthermore, XICT applies the cost-effective tariff to enhance the high cargo traffic growth. Port tariff has been reduced by 9% since 2001. Considering positive traffic level, XICT continues implement management reform program and further investing in the stateof art equipments. As far as financial risk is concerned, an effective risk sharing strategy has been applied to reduce its exposure. Port facilities are financed by MOC, Xiamen Government, ADB, Japan Special Fund, State Development Bank; and Hutchison Delta Port. XPG will launch an IPO in Hong Kong stock exchange to raise new capital for further restructuring and improving operation activities. XICT also prepares the financial assessment for future business based on the latest traffic projection and financial parameters Even though no specific guarantee has been provided from government against country risk, it is assumed that country risk might be low based on the specific factors. Active involvement of ADB in port of Xiamen project, new port law, and favorable regulations and provisions minimize the country risk. In addition, continuous economic growth and paramount competitiveness of country in international market are essential for low country risk. The port of Xiamen is located in the Xiamen free trade zone. According to foreign exchange policies, enterprise within FTZ could open foreign exchange current

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account without approval of government. Such policies grant the right to XICT to open foreign exchange current account to minimize monetary risk. Therefore risk associated with exchange rate fluctuation can easily be mitigated. Based on the prolonged experience and skilled technical know-how of HPH it is assumed that XICT can minimize operating risk at great extent. XICT also developed Management Information System (MIS) to reduce operating cost. In the case of environmental issues, essential steps have been taken by Xiamen Marine Bureau and local government that have been approved by the National Environmental Protection Agency. Environmental mitigation measures have been carried out i.e. building of two domestic sewage treatment units and one ballast water treatment plan, disposal of solid waste is carried out regularly. Implementation of above risk management methodology brings about positive outputs in the port of Xiamen. It is worth noting the success of the port of Xiamen is dependent on the significant contribution and close attention of all participants: ADB: financial and technical assistance, MOC: financial support, development of hinterland connection, favorable regulations and provisions in new port law, XPG & HDP: installing modern equipments and MIS, improving staff member skill, competitive port tariff. Furthermore, new FDI policy has provided legal right to foreign joint ventures, preferential tax treatment, right to retain and swap foreign exchange with each other, and simpler licensing procedures. The government has also attempted to guarantee to joint ventures to eliminate external bureaucratic interference and many unfair local costs. The result of the current risk management strategy can be seen in the following graph.
Figure 16: Throughput of XICT
Cargo-throughput (TEUs in thousand) 743 573 366

263 183

308

1999

2000

2001

2002 Year

2003

2004

Source: elaborated by author using annual reports of Hutchison Whampoa Ltd.

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8 8.1

Risk Analysis in the Private port model Introduction

The private port model focuses on ports solely operated by private firms. The fully privatized port is operated with the core objective to generate maximum profit. Considering maximum project profitability, fully privatized port addresses the quality of the port service that seems to be the key factor to bring about desired outcomes. Like in other port governance models, risk and risk factors in privatized port relate to operational and management activities and evaluation technique of private sector. Fully privatized ports can be found in United Kingdom and New Zealand. The primary objectives of this chapter are as follow: to describe the risk and risk factors in the private port model case study- the port of Felixstowe, United Kingdom to understand how private company implement risk allocation and mitigation strategy It would be worthwhile to explain about why government applied the fully privatization policy in port sector (in the case of United Kingdom) before discussing risk and risk factors in private port model. David Haarmeyer and Peter Yorke (1993) gave the three fundamental reasons for British government's decision to privatize the country's ports. One, public harbor boards and trusts owned ports restricted competition and increased the cost of port services. Two, ports had to be able to pursue changing market conditions and put into practice a new management and technology strategy to remain competitive with European ports, Lastly, under the control of public harbor boards or trusts, the business that ports achieved was not profitable and the realestate assets owned by the British ports could not be transferred to more economically valuable uses.

8.2

Risk and risk factors in the private port model

In the private port model, the private companys business, financial condition and operational result are particularly subject to industry trends, highly competitive market, future growth, impact of national and international regulation, labor relation etc. Risk factors for major risks usually arise from the private companys approach towards port operation and management. However private company is more conscious with regard to risk analysis and management with comparison of port authority in service port model. In particular, private companies face the construction risk due to concentrated environmental regulation rather than willingness and ability to finance construction work. As far as social risk is concerned, private company is more able to better utilize dock labor than port authority in service and tool port models. As government is no longer interested in port business, private companies have greater autonomy and incentive to adopt efficient labor practices. However, private companies are required to negotiate the wages, benefits, staffing level and other terms and conditions with employees collectively. Furthermore, labor unrest could restrict

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ability of company to maximize the efficiency of operational activities that brings about less profit or loss. Financial risk depends upon private companys ability to invest in port facilities considering new technologies and customer demand, and to maintain expected growth of traffic. It has been found that private companies have been able to make required investment. Private company usually focuses on quality of customer service to minimize financial risk. According to Hutchison Whampoa Limited (Annual report, 2004), cyclical downturn in the business of shipping lines, volatility in international trade and global economy, new market entrants, the intensification of price competition and product innovation and technical advancement could affect the port business adversely and increases commercial risk. There can be no assurance that government regulation will not affect the port activities even though government has no longer interest in port operated under private port model. New fiscal and regulatory policies or other competitive changes may pose a country risk to the overall business. Sometimes company experiences delay in the process of obtaining or maintaining licenses, permits and governmental approvals necessary to operate port activities. Monetary risk is dependent on the changeability in the interest rate and value of local currency against dollar. Operating risk can only be generated from companys inaccuracy towards assessment of operating cost. Unlike a private operator under the landlord port, private company is not obliged to achieve required throughput to avoid payment of penalty to port authority. Private company is subject to international and national environmental laws and regulations. It incurs costs for preventive and corrective actions in meeting regulatory obligation of such laws. Changes in these regulations could result in an adverse affect on financial condition and operational result.
Table 25: Risk factors in the private port model

Risk category Risk factors Construction risk -Inadequate and insufficient investment from private company -Lack of understanding of port project in terms of technical Social risk -labor unrest and failure in negotiation with employees collectively with regard to salaries, staff level and benefits Financial risk -Inability of private company in terms of proper investment considering customer demand Commercial risk -lack of responsive approach of private company to customers need intensification of price competition and technical advancement Country risk -Government regulation and policies, delay in process of obtaining or maintaining licenses, permits etc. Monetary risk -Inflation rate, fluctuation in interest rate and exchange rate -Non-convertibility of local currency Operating risk -Inaccuracy towards estimation of operational cost Environmental risk -International laws and regulation for environmental conditions -Dredging and filling of open water area
Source: elaboration of author

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8.3

Case study-The port of Felixstowe, UK (Private port model)


Geographical Location

8.3.1

The port of Felixstowe is located at southeast part of United Kingdom at North Sea. It is one of the largest container port in Europe and the largest in the UK. It is wholly owned by Hutchison Port Holding (HPH), a subsidiary of the multinational conglomerate Hutchison Whampoa Limited.

Figure 17: The port of Felixstowe

8.3.2

Port governance structure

Port of Felixstowe (PFL) is one of the private company ports owned and operated by private companies in United Kingdom. PFL was a railway company port that was nationalized in 1948 but has subsequently been returned to the private sector42. In August 1991, HPH acquired 75% shares of the port from Orient Overseas Holdings Limited (OOHL). In 1994 HPH purchased remaining 25% shares from OOHL and become 100% owner of the port of Felixstowe (website). PFL is managed as commercial companies whereby HPH owns, develops, and maintain port infrastructures, superstructures and equipments. It is also responsible for assuring port activities. PFL retains the statuary powers and responsibilities
42

The information contained in case study is obtained from MEL Thesis 2003/2004: Private sector financing of container terminal infrastructure, by Michele Acciaro , www.portoffelixtowe.co.uk, and Annual report, 2004 of the Hutchison Whampoa Ltd.

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under the legislative. National government policy makes the major privatize ports responsible for investment in infrastructures, superstructures and equipments. PFL is also responsible for security in the port area through its own statutory police force, maritime safety, maintenance of infrastructures and superstructures and equipments, marketing of port operation, and leasing of land and property within the port area 43. In short, government has no longer interest in port activities and therefore PFL is required to carry out whole port activities including investment, management, leasing, and charging port dues.

Table 26: Distribution of responsibilities of port activities in the port of Felixstowe Functions Investment in basic and operational infrastructures Elements -construction, completion and development of new port area and cargo terminal -development and control of railway from the point of entrance into the port -erection and operational of navigational light and buoys - navigation developing and maintenance Investment in superstructures - construction and development of port offices, workshop, training facilities, warehouses, transit shed etc -purchase of new tugboats, new gantry cranes etc -purchase of cargo-handling equipments i.e. RTG, Reach Stacker, Prime Mover etc Port Services Port Maintenance - Cargo-handling services & other srvices -repair of infrastructures, superstructures and equipments - environmental policy Responsibility PFL

PFL

PFL

PFL PFL

Investment in equipments

PFL PFL

PFL PFL

Port safety, security PFL and environmental and social life Provision for labor - employment of labor force and other PFL force activities related to labor force Source: elaborated by author using MEL Thesis private sector financing of container terminal infrastructure

43

MEL Thesis 2003/2004: Private sector Financing of container terminal infrastructure, by Michele Acciaro

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8.3.3

Risk management

The PFL is Private Corporation having primary objectives to achieve profitable growth by providing high standard of services to shippers and customers. The PFL has overall responsibility for the assessment and management of risks.
Table 27: Risk allocation and mitigation in the port of Felixstowe Risk category Risk allocation Risk mitigation Government

Construction risk Social risk

contractor Construction and dredging work is done by making contract with specialized companies PFL carries out Strategic working approach toward their employees. At one side it provides exceptional and safe working environment and empowerment while other side it expects them to be sensitive and responsive to customers` needs. In the financial matter, Hutchison Whampoa Ltd applies the central cash management system for all of its subsidiaries including PFL to manage the financial 44 risk . PFL applies the win and retain strategy by providing services which offer value in terms of price, quality and 45 safety . It is assumed that considering political stability and economic growth of country where port is located, country risk might be low or can be mitigated. PFL applies derivatives, for example interest rate SWAP contract and forward rate agreement with major creditworthy financial institutions. Floating interest borrowing is swapped to a fixed interest rate 46 borrowing . PFL also utilizes forward foreign exchange contracts and currency swap with banks and financial 47 institutions . Application of new computerized system called FCPS and proactive EDI system eliminate unnecessary and time consuming activities Working closely with environmental organizations such as English nature, the Royal Society, Suffolk Wildlife Trust on mitigation measures. Source: elaboration of author

Financial risk

Commercial risk Country risk

Monetary risk

Operating risk

Environmental risk

44 45

Page 60, annual report, 2004 Hutchison Whampoa Limited www.portoffelixstowe.co.uk 46 Page 61, annual report, 2004 Hutchison Whampoa Limited 47 Page 61, annual report, 2004 Hutchison Whampoa Limited

PFL

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In meeting primary objectives considering risk factors, PFL seeks to increase risk awareness and has put significant risk strategies. PFL deals with construction, operating, commercial, environmental, and social risks while risk management group of HWL develops and implements risk mitigation strategies for financial, monetary and country risks. One of the major risk factor for construction risk is the environmental hurdle. PFL seeks to manage this risk by making construction and dredging contracts with qualified companies. Expansion of infrastructures can be undertaken in an environmentally-sensitive context. European, national and local environmental requirements have been met firmly by comprehensive mitigation programs with environmental organizations. PFL is paying special attention toward labor relationships and working conditions to manage social risk. It carries out a supportive and attentive approach towards their employees. At one side it provides an exceptional and safe working environment, competitive salaries, and empowerment while other side it requires workers to be sensitive and responsive to customers` needs. As far as financial risk is concerned, HWL operates the central cash management system considering the nature and risk exposure of individual business under which groups investment and lending activities are overseen by internal audit functions. Internal audit functions include monitoring various activities such as review and approval of business strategies, budgets, plan, and the key business performance target. The general manager of internal audit function provides the information of day to day activities to the Board. Based on such information the Board determines the assessment and management of risk. The general manager also provides the assurance to the effectiveness of the risk management48. In order to manage commercial risk, PFL insists on the win and retain strategy (high customer oriented service approach). Company focuses on a high standard of performance, innovative solutions and developing long-term relationships with shippers and carriers to achieve primary objective- high profitable growth. PFL has made the large investment in rail network and warehousing facilities. Comprehensive package of facilities in terms of price, quality and safety to sea and feeder operators, efficient inland transport networks with industrial heartland as well as population areas of UK, navigational channel and quay with 15 meters depth enhance the port efficiency and competitiveness. It is assumed that considering political stability and economic growth of country where port is located, country risk might be low or can be mitigated. Risk management group utilizes derivative financial instruments in the management of foreign currency and interest rate exposures. It is strict policy of group to not utilize derivative instruments for the speculative purposes. The group enters in to foreign exchange contracts and interest rate swap to hedge against foreign currency and interest rate fluctuation.

48

Page 60 and 87 of the annual report, 2004 Hutchison Wharmpo Limited

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PFL is the first port in UK to introduce a computerized Customs clearance system known as FCPS. This system has developed by PFL, Customers and HM Customs & Excise. PFL operates extensive proactive EDI system, Navis Ship and Yard Planning, RTG real-time work scheduling and recording (RTO), a graphic based real-time management system (RTM), and a warehouse management system (WMS). Shipping Lines, Agents, Forwarders and Haulers carry out their business transactions through such systems. These have resulted in greater efficiency and further management of operating risk. As far as environmental risk is concerned, PFL meets European, national and local environmental requirements. PFL also works closely with environmental organizations such as English Nature, the Royal Society, Suffolk Wildlife Trust for mitigation measures. The expansion of Trinity Terminal gives the best example of the Ports commitment to the environment as PFL funded new Trimley Marshes Nature Reserve in return for small section of bird habitat. Even though risks are allocated entirely to PFL, effective implementation of risk management has achieved companys primary objectives- to provide a high standard of services and to develop long-term relationship with customers. Companys all times high responsive approach to customer needs, effective port and logistics services (latest warehousing facilities and logistics technology, and investment in rail network linking to industrial as well as population areas), exceptional and safe working environment with competitive reward and training to employees, central cash management system for investment and other financial needs, derivative financial instrument such as interest rate and foreign currency swaps, and pro active real time data systems (EDI and FCPS systems) all together have managed and mitigated commercial, social, financial, monetary and operating risk at utmost level. Business integrity and investment in technological innovation are one of the most fundamental factors of PFL being largest port of the UK. Risk management system applied in the PFL shows that even if risks are allocated to a single party, thorough understanding of risks and effective implementation of particular method against each risk can make the port operated effectively and successfully.

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9 9.1

Risk Analysis Framework Introduction

In previous chapters we have studied various risks, risk factors, risk identification; allocation and mitigation under the different models and case studies. Based on that, we can observe that long-term contractual relationships in any kind of sector: port or aviation, water or electricity, energy or consumer, road or rail, public or private, involve risks. Some risks can be minimized or reduced by applying appropriate risk analysis. The risk analysis process is an important tool to ensure effective use of existing financial and human resources and achieve best desired outcomes. Risk analysis continues to play a substantial role to organize whole business profitably over the life of the contract. Thus a comprehensive risk analysis framework has to be prepared to identify when particular risks occur and how it will affect to business, who is best able to manage, control, and minimize risk, and what the expected outcomes will be. The framework includes the specific measurement criteria to assess particular risk in the port business. The objective of this chapter is to prepare a common risk analysis framework.

9.2

Risk analysis framework

The port sector is subject to certain risks and uncertainties that could bring about actual result to differ materially from those expected. How these risks are identified and allocated has direct influences on the success of whole project. Herein below risk analysis framework is designed considering the major risks as described in chapter 2. We separate the risk analysis framework into following three stages. 1. Risk identification: It includes the checklist table and the Impact and Likelihood Table to determine the overall possible consequence (in terms of low, medium and high) of risk. 2. Risk allocation: It describes the risk allocation process and illustrates the risk allocation table as an example showing different parties involved in port project. 3. Risk mitigation: It states the suitable approaches for risk mitigation. 9.2.1

Stage 1 - Risk Identification

Risk identification is the first stage of risk analysis and focuses on the understanding of the existing business environment of port and identifying the areas of impediment and uncertainties associated with the investments and management strategies and expected business objectives. Considering the existing circumstances of the port sector, comprehensive risk identification is critical. Here we categorize risk identification into two steps: 1. Checklist of risks (asking fundamental questions), 2. Impact and Likelihood of Risk Table

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The first step is concerned with various fundamental questions for each risk while the second step classifies impact and possibility into five categories. Both steps have to be applied for each question described in the risk identification checklist table in the appendix 1. Beginning with the checklist, we have to consider each question carefully. Once we get the result of each question, we have to place it in the impact and likelihood table to determine its consequence on the port. Based on the outcomes of all questions, overall consequences of individual risk can be determined. It is worthwhile to explain that risk identification table consists of the most common questions that are usually relevant to any kind of port project. User of the risk analysis framework can add or consider more questions that are significant to project considering specific characteristics of the port. Even though a checklist table shows what questions have to be considered by public authority or private sector, author strongly suggests that it would be better for them to take in to account only those questions that are relevant to project. In addition, Public authority or private sector should also consider those questions that are not under their title in the checklist table but they believe they are relevant to the project. It is also necessary to describe that the primary objective of questions is to provide an understanding of the initial step of entire risk analysis process. Questions are not only enough to determine the precise consequences of the risk. They give the significant indications and insight for identification of risk. The following chart shows how we can get the result of each question that is relevant to put in to the impact and likelihood table.
To what extent it affects On what areas it affects

Question

Answer

To whom it affects

Public Authority

Private sector

Identify how, what possibility, and to what extent it affects

Identify how, what possibility, and to what extent it affects

Put the result in to the impact and likelihood of risk table

Figure 18: Risk identification chart Source: Elaboration of author

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Assess impact and likelihood Assessing impact and likelihood of each question is quite critical. However, we can use the best common practice i.e. the application of expert knowledge, previous experience and available public literatures for determining impact and likelihood of each question.
Table 28: Impact and Likelihood of Risk

High Extreme

Considerable Serious Manageable

Minor

Moderate

IMPACT

Serious Usual
Rare Unlikely Medium LIKELIHOOD High Almost certain

Very low

Source: Drawn by author using different materials

Usual

Consequences of risk are relatively very low or minor. Parties would transfer them at low premium. However, risks should be reviewed periodically. Usually, parties have enough experience to control and manage risks well. Consequences of risk are not relatively severe. They can be manageable by appropriate parties applying simple mitigation strategy.

Manageable

Serious

The consequences of the risk would have materially severe but not considerable. Risk must be allocated to the party or parties best able to control and manage it. Both appropriate risk allocation and developed risk mitigation are highly recommended. Consequences of risk would be considerable impact on whole project continuity. Risk sharing approach must be applied. Risk must be shared among all parties based on ability and willingness of parties and providing specific guarantees.

Considerable

Having applied risk identification table and impact and likelihood table, we can distinguish each risk in terms of high, medium and low consequences and occurrences. Once the impact of risks is made clear, the next step is to consider risk

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allocation process based on the optimal rather than maximum risk allocation among port authority, private sector and other parties . 9.2.2

Stage 2- Risk Allocation

Achieving desired outcomes requires allocation of risk to the party or sharing of risk among parties best able to manage it. Each risk has to be placed where it can be best managed to reduce the probability and severity of risk. In the risk allocation strategy, we should consider following chart.
What types of risk are allocated?

Who involve in the project?

Single party (Public authority or private sector)

More parties (Public authority & private sector)

How risk is allocated to individual party?

How risk is shared among parties?

Figure 19: Risk allocation chart

The first and second questions are concerned with the types of existing risk and number of parties involved in the port projects. Before risk allocation, ability and willingness of each party has to be determined. Based on the ability and willingness, risk has to be allocated to the party or parties best able to control mange and minimize it. In the case of single party (service port model), internal risk allocation is recommended. Port authority should set up different departments for individual port activities and allocate risk to respective department. For example, human resource department is obliged to deal with labor relation and problems arising from labor related activities or issue. In the public private partnership under the landlord model, the way the concession agreement or lease agreement between port authority and private sector made, has to be taken into account extensively for risk allocation strategy. Even though private sector is best able to minimize the risk, he might not be content to carry risk considering terms and conditions of agreement. Therefore it is quite important to make the contract in such a manner that provides private sector with certain autonomy or right, and reasonable reward to carry risk that he is best able to manage it.

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The first question under the more parties title deal with the allocation of risk in terms of primarily, partially, largely and solely. It is quite difficult to define which part or portion of risk has to be allocated to respective parties. It can not be calculated. So the best manner is to allocate particular risk largely or solely to parties best able to manage and minimize by providing specific guarantees. For example, in the port of Maputo, financial risk is allocated largely to commercial banks and concessionaire with providing MIGA and Government guarantees of backing up entire loan. The last question states risks that can not be managed and mitigated by one parties, must be shred among all parties. However, it is worth noting every party may not be liable for sharing risk equally. It depends on the responsibilities and share of profit. In service port model and private port model where port authority or private sector is entirely responsible for risk, sub-contracting method would be best option for risk sharing. Following risk allocation table shows some examples of the appropriate risk allocation among parties. The contents of the table are examples. They should not be considered to be the appropriate risk allocation for each port.
Table 29: Risk allocation table Sources of risk Public Private authority operator Political instability Quality of workers Availability of finance Increased Interest rate Legislation changes Construction cost overrun Tax regulation changes Environment policy Operating cost overruns Merchant Banks Preferred Risk allocation Largely to government Solely to private sector Partially to private sector and merchant bank Solely to private sector Shared Strongly Depending on the contract Primarily to private operator Solely to Government Solely to private sector

Example A simple imaginary case study is given to make it more understandable how to use the risk management in the real practice. Suppose the port of Sea land 49 located in one of the African country has potential of being an important port for economic development by providing efficient service to neighboring land locked countries. As Government is not able to finance whole project, it introduces privatization under the concession agreement in the form of BOT. Under such condition, how will following questions (taken from risk identification table) be considered is discussed below. Who will finance the whole project? Who will bear the cost of retrenchment and outstanding pension liabilities?
49

Sea land is the Imaginary name of the port.

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The answer of the first question relates with financial issue of the project (financial risk). We suppose that project is financed by concessionaire 80% and financial institutions 20%. Parties to whom it affects are concessionaire and financial institutions. Considering political instability and lower economic growth of country, we can place the financial risk in the high likelihood with extreme impact (considerable) cell in the impact and likelihood of risk table. Risk is allocated largely to concessionaire and only partially to development financial institutions. The best approach for managing this risk is a political risk guarantee to back up the commercial senior debt from government and a partial risk guarantees from the World Bank Groups Multilateral Investment Guarantee Agency (MIGA). The answer of the second question is associated with social risk. Parties to whom it affects are concessionaire and public authority (government). We suppose that before introduction of privatization, government undertook a major job reduction programme and allocated appropriate amount for redundancy payments and outstanding pension liabilities for workers. In this case we can place the risk arising from this condition in the unlikely likelihood and moderate impact (manageable) cell in the impact and likelihood of risk table. Risk is allocated solely to government.

9.2.3

Stage 3- Risk Mitigation

Risk mitigation is the final step of risk analysis framework. It involves the various mitigation approaches for risks. Once risks are allocated or shared, we must identify the best mitigation approach of risk. Based on the previous chapters and casestudies, risk mitigation table has been drawn to show some of the best approaches for risk mitigation. It is not only enough to have best approaches but we have to apply them considering current and future aspects of the business and to what extent we can mitigate the risk by using these approaches. For example, the mitigation process can be as follow: Identify the best approaches Measure possible outcomes of approaches Evaluate how long applied approaches will give us best result

Benchmark can also be part of risk mitigation. We can apply the best risk mitigation strategy by considering various ports operation and management system. For example, it would be better for the port of Latakia, Syria to make the port of Maputo as benchmark particularly in respect of financial arrangement, road and rail networks, exchange policy, and specific amendments in legal provision. It is important to point out that following table containing various approaches may usually appropriate for primarily risk mitigation. However it might not be best alternative for risk mitigation process in every port, as approaches are based only on previous chapters and case studies.

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Table 30: Risk mitigation approaches

Risk category
Construction risk

Elements of the risk


Construction cost overrun Construction time delay Financial crisis Changes in contract provision Underestimation of quantities of material and material price

Mitigation approaches
Design and built contract with qualified construction company with performance guarantee Typically protected against changes in contract framework by the specific clauses in agreement Fixed price contract with suppliers and contractors in respect of material Retraining program Long-term agreement with labor-union for future employment Job reduction program by government Redundancy and professional reintegration program by government and private sector together Merit system Third-party Contract-

Social risk

Quality of labor force Outdated workforce and overstaffing National law regarding labor force Interference of labor-union in port operation Specific status given to Dockworkers Lack of availability of finance Inability of government Inappropriate concession agreement Factors related with country risk

Feasibility study where project financed by Government Assurance of government regarding availability of finance Insurance from multilateral institutions Guarantee from exim bank Government guarantee Commercial Market condition Competitive port tariff risk Excessive port tariff Contract with shipping lines Poor inland transport system State-of -art facilities Intra and inter port competition Contribution of government or port authority in development of inland transport system Inadequate port facilities Market oriented strategy Other responsible factors Attempt to provide added value services Country risk Expropriation or nationalization Political and economic risk guarantees from government Political instability Political guarantee from credit agents Adverse economic Involvement of multilateral institutions Tax policy legal right from government in the case of Changes in Legislation expropriation or nationalization Monetary risk Increased interest rate Off-shore account Unfavorable exchange rates Guarantees for convertibility of currency from central bank of host country Non-convertibility of local currency SWAP contract with third-parties Operating risk Operation revenue below par Selection of Experienced operator Operating cost overrun Fixed-price contract with operator Better-than expected reward systemEnvironmental Dredging activities Passing on construction company risk Land reclamation Working with environmental organizations Others Specific mitigation programs -Third-party contract: Port authority or private operator hires the necessary personnel from private agency or companies under the contract whereby private agency or companies are liable for any conflict or problems arising from labor relation. -Better-than- expected reward system: It offers the specific reward to operator if expected performance is achieved by him. Financial risk

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Who Benefits? And what are the Benefits? The beneficiaries of this risk analysis framework can be: Port authority: It will benefit through enhanced value of port, efficient port management and operation, and stable and secure income Government: It will benefit in terms of economic development and public budget Private operator: Private operator will achieve profitable growth and provide high standard of services and performances to customers Merchant Bank: if merchant bank participates in project, It will receive the stable and prolonged interest rate with the security of payment of loan Users: shipping lines will benefit through improved port facilities that reduce the waiting times.

The benefits of the risk analysis framework can be: Effective use of resources Continuous improvement Achievement of strategic objectives and business planning Justification of public budget Reducing operating cost Better services to customers

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10 Conclusion and Further Research 10.1 Conclusion


In todays increasingly competitive international market, public or private sectors can not survive for very long without taking risks. They continue face threats from incompetent market strategy, introduction of new technology, entry of new competitor in market, economic disaster, and political upheavals. Port sector is also struggling to survive in competitive environment and concerns about business risk management. Particularly, the port sector faces the construction, social, financial, commercial, country, and environmental risks. The major risk factors include the national and international trade, political instability at regional as well as at global level, environmental damage, etc. Decisions made by port authority or port operator are very often fraught with risks not only for them but also for shareholders and perhaps country where port is located. There are four different port governance models i.e. service port ,tool port, landlord port, and private port models and the choice between them depends upon the socioeconomic structure of country, location of port, the way the port organized and managed, and how responsibilities are allocated between public and private sectors at optimum level. Each port governance model has different objectives. Port governance models are different from one other on the basis of allocation of rights and responsibilities of investment, regulatory and operational activities. Like other public or private sectors, it can not be certain that every port project will be performed successfully. Port can not be operated effectively and achieved defined tasks due to lack of financial availability, inefficient port management, and of course poor assessment of risks, risk allocation and risk mitigation strategies. It thus results in a failure of whole port project and a loss of investment whether public or private. The common risk factors in service port model include inadequate public budget, socio-political labor law, high political instability and overlapping responsibilities. In the case study of the port of Latakia we have seen that the poor management and unresponsive approach of public port authority towards customer needs as well as inadequate risks assessment, risk allocation and mitigation have made the port inefficient and have experienced under-utilization of port facilities. Under the tool port model the port is usually financed in the same manner as in the service port model. The characteristics of tool port model in terms of risk and risk factor are also the same as that of services port model. However commercial, operating, and some extent financial risks are shared between port authority and private cargo-handling firms. From the result of the case study of the port of Shahid Rajaie, Iran, it has been outlined that port is threatened to extreme financial risk and commercial risk in terms of underinvestment and under-utilization of port facilities respectively. It is worth noting movement of Shahid Rajaie port from tool to landlord port model indicates explicitly that private sector involvement becomes inevitable for financing port facilities and managing whole port affairs effectively in the present era of cutthroat competition. As far as the landlord port model is concerned, the primary risk factors are funding arrangement between government and private sector, retrenchment payments,

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pension liabilities and retraining, contractual relationship between port authority and private sector, inter and intra port competition, hinterland connectivity with port, tariff and quality of services etc. In the case of the port of Maputo, we have seen the best risk assessment and management practices. Bankable and robust concession agreement has been emerged as the cornerstone of the introduction of successful privatization under the BOT agreement. Author strongly recommends that risk assessment and management practices applied in the port of Maputo are the best benchmark for other ports considering respective circumstances of the particular port. Even though social risk is considered to be the prime obstacle in the port of Long Beach, Hanjin operates the terminal T successfully under the long term lease agreement. Active involvement of port authority in the Alameda Rail Corridor shows the best example of the risk awareness of the port authority. In the port of Xiamen, effective implementation of risk sharing and management policy has achieved the objectives of all participants: ADB and governments objectives: to promote the economic growth of region and Hutchison Ports Holdings objectives to make the reasonable rate of return on the investment. Based on the three case studies under the landlord port model, it has been found that successful port project rests on not only risk allocation and mitigation by public sector or private sector alone but unique risks must be allocated and mitigated by project lenders (merchant banks), Project Company (private sector) and public authority together. We can conclude that landlord port model is the appropriate port model in the present era of competitive environment. The private port model has been found in United Kingdom and New Zealand. It focuses on ports solely operated by private firms with the core objective to generate maximum profit. Risks and risk factors in privatized port are concerned with the companys approach towards port operation and management and risk evaluation techniques. The port of Felixstowe shows that even if risks are allocated to single party, thorough understanding of risks and effective implementation of particular method against each risk can make the port operated effectively and successfully. A risk analysis framework has been designed considering major risks, risk factors in each port model, and risk allocation and mitigation process applied in six case studies. It has been categorized into three parts: risk identification, risk allocation and risk mitigation. Risk identification table consists of important questions usually arise in the common practice of any kind of port project. Risk allocation and mitigation have provided better insight and understanding of how risk is managed at best way by allocating to parties best able to assess, control and managed, and by applying appropriate mitigation approaches.

10.2 Further research


It would be interesting for further research about the risk analysis in real practices and compare the risk management strategies of various ports under the same port model. Author has made the number of recommendations regarding further research specifically in the landlord port model in the following areas:

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Further research is needed to evaluate risk analysis in specific ports of developing countries operated under the landlord port model and to make appropriate feasible risk management model. Additional research is required to make financial model for calculating Net Present Value (NPV), internal rate of return etc. It would be interesting to develop appropriate risk management model under the landlord port model for the port of Latakia making assumption if port wants to be operated under the landlord.

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Bibliography
1. Annual Report (2004), Hutchison Whampoa Limited 2. Asian Development Bank (2000). Developing Best Practices for Promoting Private Sector Investment in Infrastructure: Ports. Manila, Philippines: Asian Development Bank 3. Asian Development Bank (2005), Xiamen port project in the peoples Republic of China 4. Brian Slack (2001), Globalization in Maritime Transportation 5. Cadwalader (2003), International securitization & structured finance report, May 15,2003, volume 6, no.9 6. David Banks (2001), Best practice guidelines for investment promotion, OECD-China Conference, Xi'an, China 7. David Haarmeyer and Peter Yorke (1993), Port privatisation: an international perspective 8. Drewry Shipping Consultants Ltd. (2002). Global Container Terminals: Profit, Performance and Prospects. 9. ESPO (2001), Environmental Review Report 10. F. Wharton (1992), Risk Analysis, Assessment and Management, page 5. 11. Hoffmann, J (2001). Latin America Ports: results and determinants of private sector participation. International Journal of Maritime Economics, Vol. 3, No. 3, pp. 221-241. 12. Industrial Project, America, the port of Long Beach, www.porttechnology.com 13. Juhel, M H (1998). Globalisation, Privatization and Restructuring of Ports. 10th Annul Australasian Summit, Ports Shipping and Waterfront Reform. 14. Juhel, M H (2001). Globalization, Privatization and Restructuring of Ports, International Journal of Maritime Economics, Vol. 2 No. 3 pp 139-174 15. K.C. Fung, Hitomi Iizaka, Sarah Tong (2002), Foreign Direct Investment in China: Policy, Trend and Impact 16. Mary R. Brooks (2004), the Governance Structure of Ports. Review of Network Economics Vol.3, Issue 2 June 2004 168 17. MEL Thesis 2003/2004: Private sector financing of container terminal infrastructure, by Michele Acciaro 18. Ministry of Transport of Syria Arab Republic website http:/www.mot.gov.sy/en/en.htm 19. The department of finance and administration, Austrian Government (2005),Public Private Partnerships, Guideline: Commonwealth Policy Principles for the Use of Private Financing, Risk Management 20. The port of Felixstowe http://www.portoffelixtowe.co.uk/ journal

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21. The port of Latakia httml://www.lattakiaport.com/english/ 22. The port of Long Beach http:/www.polb.com/ 23. The Port of Maputo http:/www.portmaputo.com/home.html 24. The port of Shahid Rajaie http:/www.pso.ir/old/rajaie/pages/fprofabbas.htm 25. Thomas A. Grigalunas (2001) Comprehensive Framework for sustainable container port development for the United States East Coast 26. Toms Serebrisky, An assessment of port reform in Argentina: outcomes and challenges Ahead, The World Bank 27. UNCTAD (2003), African ports: reform and the role of the private sector Report by the secretariat of UNCTAD 28. UNCTAD (1998), Guidelines for Port Authorities and Governments on the privatization of port facilities; Report by the UNCTAD secretariat 29. van der Veer, J P (2001). Private Sector Involvement in Ports: Economics and Policy. Topics, NERA Working Papers, No 24, pp 1-13. 30. World Bank (2001). Port Reform Toolkit. The World Bank Group: http://www.worldbank.org/transport/ports/toolkit.htm. 31. World cargo news, June 2004, http:/www.worldcargonews.com/

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Appendix Appendix 1: Risk Identification Checklist Table


Questions Construction risk Who will finance construction project? What is the scope of the construction work and of the specifications for project infrastructures? Does port authority provide the financial support for construction? If yes, what type of? Can I associate with construction work from the design phase? Can I make a fixed price contract with construction company under which construction company assumes the risk of delays and higher-than-expected construction costs? Who is responsible for delays in construction and higher-thanexpected cost? How will the increased cost of construction due to changes in environmental legislation be dealt with? May port authority impose particular conditions and constraints that result in construction cost increases? Social risk Do exiting labor practices are flexible and effective? Are all categories of personnel skilled, knowledgeable and experienced? What kind of status dockworkers enjoy under the national law? Are port activities dominated by labor-union? Who will bear the cost of retrenchment and outstanding pension liabilities? What type of terms and conditions will be appropriate for future employment? Will government assume responsibility of future problems arising from labor relation or agreement? Financial risk Who will finance the whole project? What is the mechanism for financing the project? What assurances will financiers (project sponsors) have in respect of availability of fund when required? Will local or international banks offer commercial loan? Will multilateral institutions provide financial support to project? Will private sector get the political or economic risk guarantees from government? How will government take necessary steps to make concession agreement more bankable (to protect the lenders against certain risks)? Will private sector able to work with public entity? Will private sector able to generate acceptable rate of return? Commercial risk What is the current throughput of port? And what is the Public authority Private sector

X X X X X X X

X X X X X X X X

X X

X X X X X X X

X X X X X

X X X X X X X

X X X X

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maximum capacity of the port in terms of throughput? What are the responsible factors for current throughput? How significant is port cost in determining market competitiveness of port customers-? Will customers take the advantage of lower entire transport cost using my port? If yes how much it will be in comparing neighboring port? What strategy can port apply to attract and lock-in customers-? Where does port have comparative advantage over competitor ports? Does port face intense intra or inter port competition? Who will be my competitors -global terminal operator, shipping lines, local dominated operator or quasi-government corporation? What are the policies- improving port facilities, port tariff, hinterland activities etc- of the neighboring ports? What is the market strategy of neighboring ports? What structures and level of port -tariff will be competitive with neighboring ports? Does port suffer from lack of adequate hinterland networks? How do neighboring ports connect with industrial or/and consumption areas in comparing with own port? To what extent port compete with neighboring ports in land side transport activities? What types of ship can port accommodate? How custom processes affect port effectiveness? How much throughput will I have to achieve to reach break-even point? How will I achieve it? Country risk How stable the political situation, economic condition and competitiveness of the country? What are major responsible factors for economic development of country? How does existing legal framework influence port activities? Is there a political involvement (corruption) in port sector? If yes What extent does it affect the port performance? Is there any possibility of changes in legislation and regulation that makes private operator less able to deal with port activities? If yes will government protect the operator against changes in legal issues? Will concession or lease agreement include a contract revision clause to avoid a situation that put the financial viability of project in jeopardy? Will government provide political or/and economic risk guarantees? Will legal right of private companies be protected in the event of nationalization or/and expropriation? Will project involve export credit agencies to secure debt and equity against political risk? Will any kind of insurance be available from MIGA or /and private insurance companies? Monetary risk Is host countrys currency stable or/and strength against dollars? Is interest rate stable?

X X X X X X X X X X X X X X X

X X X X X X X X X X X X X X X X X X

X X X

X X X

X X

X X X X

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Will the government approve of opening off-shore account? X Will I repatriate capital and profit? If yes how many percent? X Will central bank of host country give the exchange rate risk X guarantee? Is it possible to make SWAP contract with third parties with X X regard to fluctuation of exchange rate and interest rate? Will government provide any type of fiscal benefits i.e. tax X holidays, exemption from custom tariff, tax refund, and lower income tax? Operating risk What are the possible factors for excess operating cost? X X Can operating liability be spread among the operator and subX contractor? What penalties would the operator face for non-compliance with X specific obligation related to operating cost? What methodology will be used to diminish operating cost X X overruns? Will fixed-price contract be appropriate method to transfer the X operating cost overruns to operator from masterconcessionaire? Environmental risk How will the adverse impact of construction of port facilities on X X the existing marine environment reduce? Who will be responsible for paying penalties for noncompliance X with environmental regulations? How will national and international laws and regulations impose X X constraints on the project? Note: - shows that these questions have been taken from World Bank port reform toolkit, module 3. Note: In the checklist, cell with X symbol indicates that port authority or port sector considers questions whose cell is filled by X under their title. Public authority refers to state government, municipal government, port authority and governmental departments. Private sector includes the private port and terminal operators, merchant banks, contractor and other private entities

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