Construction risk

Construction risk
See also
Litigation risk Property portfolio Full Ratchet Agile project management methodology Indirect loss Dynamic risk Maintenance strategy Contribution analysis Cultural audit

Construction risk is one of risk types in infrasctructure projects along with (D.D. Wu 2011, p.51):

Contract risk
Management risk
Environmental risk
Design risk
Time risk
Client risk
Financial risk
Region risk

Measuring construction risk

"Construction risk is derived by estimating the difference between the ex post or outturn cost and the ex ante or expected cost expressed as a percentage of the ex ante cost estimate." (F. Blanc-Brude, D. Makovsek 2013, p. 5). According to F. Blanc-Brude and D. Makovsek construction risk has also big impact in project finance. To describe this issue it is better to split the term of construction risk into two dimensions: exogenous and endogenous risk. It can be said that construction risk in infrastructure projects can be result of two factors:

uncertainty about the conditions under which the numerous tasks can be accomplished e.g.: ground conditions, the weather, unexpected archaeological sites, etc. It all makes the actual cost of building infrastructure uncertain. These risks are called exogenous i.e. there is no way to change their frequency.
exposure to uncertain costs and what can be done about it. This is an agency problem: if the risk of higher construction costs is not borne by the side resposible for building there is moral hazard i.e. little encouragements to control costs. Moreover, methods like that are also likely to suffer from unfavorable selection: the firm choosed to build the project may not be the best one in controlling costs. This type of risk is called endogenous (2013, p.6). It is expected that endogenous risk will be different under miscellaneous incentive schemes. As it has beeen described, infrastructure project finance creates an incentive scheme that should influence construction risk. This kind of risk is typically transferred from the sponsor company (SPE), to the builder, who pledges to a date-certain and fixed price construction contract. In case of project's construction phase goes wrong the risk may come back to the sponsor company, which is responsible in the end (F. Blanc-Brude, D. Makovsek 2013, p. 9).