Building Recycling Plants Brings Risks

Marc J. Rogoff and John F. Williams

When implementing a recycling program, collection, processing and marketing are not the only issues at hand. Of equal importance are institutional issues such as project procurement, ow-nership, financing and risk.

The procurement approach dictates who will provide a project's engineering services as well as its design, construction, start-up and operation. It also establishes what method will be used, as well as which legal guidelines to follow, when seeking services or equipment.

In general, three approaches can be used to procure services for recycling projects: conventional or architect/engineer (A/E); turnkey; and full-service.

The conventional or A/E approach is the most widely used. With this approach, a community retains a professional engineering firm to help plan and design a project. Acting as an agent for the community, the engineer prepares equipment and system specifications for public bidding and contributes to the design of the project.

Following bid evaluation, the engineer will monitor the project's construction to ensure that the proper materials and equipment are being used. The engineer also assists in the project's start-up and testing stage.

MRF projects have incorporated some aspects of full-service procurement in the A/E approach. Bidding on a complete package of processing equipment, instead of on individual pieces, is an example.

Using the turnkey approach, a single entity is awarded a contract for the project's design, construction, equipment and start-up. The turnkey contractor selects the equipment and supplies, designs and constructs the project or subcontracts portions of it. No matter who completes the work, the contractor is responsible for the project's construction. Once the facility is constructed and start-up testing proves successful, the community can operate the plant or it may contract its operations.

An extension of the turnkey approach is to assign total responsibility for the MRF's design, construction, equipment, acceptance testing, operation and ownership to a single entity or full-service contractor. Here, the community is provided with long-term operation and maintenance services. This procedure usually includes a contract for design, construction and acceptance testing and another contract for project operation and maintenance.

Procurement approaches differ in the level of control that the community can retain. For example, full-service procurement shares risk with the private sector. Construction price guarantees are available as well as construction guarantees within a specified period. Also, performance levels are guaranteed and fixed annual operating and maintenance expenses are established, which are subject to a negotiated escalation formula.

In comparison, a turnkey procurement contractor typically guarantees a maximum construction price, to complete construction by a specific date, to demonstrate specified performance levels prior to the community's acceptance and a limited warranty on work and materials.

With the A/E procurement approach, the shared risks include completion within a specified construction period and demonstration of specified performance levels.

The community must first establish its goals for project control, ownership and risk allocation. Its position on project control is influenced by: traditional community practices; the public's perception of community involvement in an environmentally sensitive issue; and the community's technical, managerial and finan- cial capabilities.

They also should consider if they want to own and/or operate the project. Further, evaluate whether the community has the resources to operate the project efficiently. Also, how involved does the community want to be in project design, technology selection, site layout and architectural standards?

The A/E approach is appropriate for communities that want to own and operate the project. It allows the community to control the design elements of the project, which often opens the door to public concerns. However, the A/E approach, which requires more community resources to develop and operate the project, exposes the community to greater economic risks. Construction risks include cost overruns, lack of sole-source responsibility and potential technical failure. These risks are manageable and can be mitigated by an experienced A/E firm. In addition, a good construction manager can minimize scheduling problems.

Operational risks pose a greater problem with this approach. However, proven technology and equipment will minimize the operational performance risks. Most publicly operated projects will require a qualified technical staff to ensure that the facility is operating adequately. While technical staffs may prove es-sential to the project's operation, some financially-strapped communities may not be able to afford additional salaries.

The turnkey procurement approach is suited for communities that want full responsibility for construction, but also want to relinquish it when the plant's specifications are determined, except for the cost of work change orders. Because the community is responsible for operating the facility over the long-term, communities should monitor the design and construction. Additional monitoring expenses, coupled with the profit margin for ac-cepting construction responsibility, can make the turnkey approach costlier than the A/E approach.

The long-term performance of the facility is the major risk of the turnkey approach. This risk can be lessened by using proven technologies and financially secure contractors. To make a profit, the contractor must construct the plant efficiently, which may result in higher capital costs. A modified turnkey approach, which requires the contractor to operate the plant for one to five years, may alleviate this concern.

The full-service procurement is best for a community who wants to use a service to operate its recycling program. The ownership of the project will determine how much control is available to the community. For example, if the public maintains ownership, then the community can require the operator to respond to public requests. However, if the community takes more control of operating procedures, the full-service operator will take fewer risks.

If the community seeks private ownership, the public's control will be limited to contractual rights such as annual inspections. The community also must recognize that it would be responsible for waste disposal if the vendor claimed bank-ruptcy, insolvency or if it shut down.

Full-service procurement offers the greatest opportunity for the community to share construction and operational risks with the private sector. Since one company is re-sponsible for all aspects of the project, the vendor will guarantee operational performance levels, an an- nual operating and maintenance fee and material floor prices.

These guarantees provide the community with a more balanced risk than with A/E and turnkey projects. However, the contractor also may expect a higher operating fee for assuming these risks. Changes in law or other risks that are beyond the contractor's control will still be assumed by the community.

Corporate sponsors with access to proprietary resource technology have recently entered this industry. Communities should establish contractual rights to maintain an independent financial guarantee of the parent company and its assignees and to ensure the availability of any proprietary technology.

When a recycling facility is privately owned, communities can use federal tax benefits to subsidize project costs. Also, equity contributions will reduce the annual debt service requirement through an initial contribution and smaller bond size, or through annual contributions. These factors must be considered when the owner sets the project's tipping fee.

Risk Assessment Risk is the possibility that an event will have a detrimental impact on a project. A risk assessment involves evaluating all possible im-pacts and the methods by which risks can be reduced/mitigated or shared/allocated. This assessment defines the community's risk and determines the implementation strategies which will reflect its risk.

Risks can occur in project construction; the waste stream; project operation; materials market; and financial and contractual matters. The community is responsible for events which they caused or for those circumstances which are beyond the contractor's reasonable control. The contractor is responsible for events which it caused.

Most risks will financially affect a project in the form of a cost overrun or increased capital requirements. Other consequences include the in-ability to use the project for commercial recycling, which decreases landfill capacity; increased operating and/or maintenance costs; lost or lower than anticipated materials revenues or tipping fees; temporary or permanent MRF shutdown; and failure to make debt service payments.

To reduce or lessen risks, select only proven and reliable technologies. Other methods include selecting credit-worthy contractors with demonstrated performance and management skills; selecting project design and operating criteria that will compensate for variations in waste composition and supply; providing screening measures for hazardous waste and protection from explosions and floods; and making provisions for additional air emission equipment. Other ways to reduce risks include legislative control of waste deliveries, establishing reserve funds for major repairs and securing reasonable insurance policies.

To establish a successful risk sharing arrangement, try the following strategies:

* Make the risk allocations equitable to all parties.

* Establish a good working relationship between the community and the vendor.

* Use positive incentives, such as revenue sharing, to ensure performance.

* Provide flexibility in long-term operating agreements so that a contractor can maintain minimum profits during hardships.

Like any other operation, recycling is a risky business. Fortunately, owners usually can determine the right amount of project control to reduce their risk liability.