Don't delay in modelling a delay!

By Marc Casal on December 8 2010

The word “delay” strikes fear in any sponsor or project financier. This fear is also felt by the financial modeller, who has to grapple with modelling the cashflow impact of delays. Although the key operators structure around the risk, the impact of a construction delay can be material. With this in mind, how do we go about including robust delay functionality in a project finance financial model?

Financial modelling of a delay phase in a project finance model

It is common practice to incorporate a construction delay in a financial model by extending the construction phase. This is definitely the fastest way to estimate the financial impact of a delay. However, this approach assumes that the EPC contract and construction facility have this flexibility. In practice, this is generally not the case.

At Navigator, we model a standalone delay phase – reflecting just how important it is. This approach actually simplifies the financial modelling of the transaction and makes it easier to apply sensitivity analysis. This simplicity is largely achieved through the use of binary flags.

Making use of a separate phase clarifies that the delay is in fact a gap between the completion of construction and the commencement of operations, rather than an increase in construction duration. The use of a different phase is also easier to interpret visually when conditional formatting is utilised (see the screenshot above and our video blog on conditional formatting).

Points to consider when modelling a construction delay

When modelling a construction delay in a project finance model the following should be taken into account

Link events which occur between the end of construction and the start of operations (such as when construction capex is first depreciated, when loan tenor and grace period commence or when construction facilities are converted to term facilities) to the delay end date rather than the construction end date.
Make sure that the delay duration matches the timing of the model. For a model that has monthly construction and quarterly operations, adjust the length of the delay so that it finishes at the start of a calendar quarter. This may not be the case in reality, but this approximation is widely accepted and significantly reduces model complexity.
It is important to simplify delay assumptions. There can be an array of adjustments specified in construction contracts to account for delays such as liquidated damages, ongoing interest costs, site overheads etc. However, there is a trade off between the increased accuracy of the model and the extra time it takes to implement the changes. It is also important to sense-check delay outputs.
In some projects there may be pre-operations cashflows, which start to occur towards the end of construction. Delays will affect the timing of these cashflows. Pre-operations cashflows are quite complex to model, but simple solutions have been discussed at our previous blog on this matter

Summary

Project stakeholders often do not want to consider delays, but their inclusion in the financial model increases the quality of scenario analysis and output data. In modelling a delay, please ensure that

A distinct delay phase is modelled, rather than extending construction
Operations timings are linked to the end of delay, rather than the end of construction
Delay ends at the beginning of an operations period
Delay assumptions are simplified