Costs: The high-yield market was thinner and more volatile compared to investment grade market, creating pricing and availability risk. "width": "800" Pre-completion risks and mitigationTiming and completion risk: Failure to meet the intermediate milestones in a complex project may jeopardize the timely completion of the entire project as well as increasing costs The project is a complex one consisting of multiple components including field facilities, pipeline system, and the upgrader facilities Sponsors dependent on proceeds from selling the early production oil to fund part of the construction Failure to meet completion criteria would make all non-recourse debt due and payable Both Conoco and Maraven had significant project experience to handle the execution complexities An independent evaluator assessed their execution plan and concluded that the milestones are aggressive but within reach, and that the plan complies with local and international regulations and standards (a factor that would help mitigate likely regulative delays) Both sponsors made commitments (such as contingency funding for unexpected cost overruns) guaranteed by parent companies to ensure successful completion of the project According to an independently conducted assessment, the development of a third party market was expected in 3-5 years, and that the syncrude output would sell at a $1/barrel premium. }, 104 "name": "Why use Project Finance", Field development was the less risky part of the entire project for the sponsors, because upstream operations including field development and production was one of the core business areas where they were very strong at. "@type": "ImageObject", Major project contracts:Construction Contract: A contract defining the turnkey responsibility to deliver a complete project ready for operation (a.k.a. "@context": "http://schema.org", { "name": "The role of IFC Providing long-term capital", \u20ac900m A2 Road project in Poland. { Structuring the project contracts to allocate risk, return, and control. Corporate finance for the development of the field system and project finance for the pipelines, Debate on unstable political structure and how Chad would use its share of project revenues, WBs introduction of Revenue Management Plan to target Chad Governments returns from the project for developmental purposes, and debate on the likelihood of effectiveness of such a plan, The lead sponsor, ExxonMobil had AAA debt rating, very strong balance sheet ($145M assets) and $16M cash flow Could afford the field investment in a less costly way relative to project financing. Independent reserve certification. "name": "Case examples to value creation", }, 91 IFCs concerns are the size of the project, as well as the political risks of doing business in Mozambique. "@type": "ImageObject", }, 97 { Major characteristics:Historically formed to finance large-scale projects Industrial projects: mines, pipelines, oil fields Infrastructure projects: toll roads, power plants, telecommunications systems Significant financial, developmental, and social returns Examples of project-financed investments $4bn Chad-Cameroon pipeline project $6bn Iridium global satellite project $1.4bn aluminum smelter in Mozambique 900m A2 Road project in Poland Corporate financing as opposed to project financing helped ExxonMobil keep the project as part of its portfolio and reduce the risks. "@context": "http://schema.org", "width": "800" The sponsors are interested in structuring a limited-recourse financing deal with IFC involvement. "contentUrl": "https://slideplayer.com/slide/5357710/17/images/105/Cost+of+capital+calculation%2A.jpg", Deterring sovereign interference. ", "width": "800" "@context": "http://schema.org", A permanent management team was discussed, that would work exclusively for the project: Management compensation package was easier to craft, since it was a single purpose company with limited and well-defined growth opportunities. Project financing for the export system:Export system was the riskiest part of the project. "name": "Case examples to value creation", (Corporate Finance) Risk spreading \/ pooling. "description": "BP Amoco. { Effective contracts may provide: Better risk shifting: better distributions of cost. "contentUrl": "https://slideplayer.com/slide/5357710/17/images/11/Major+project+contracts%3A.jpg", "name": "Acknowledgements The content of this presentation has been derived from:", "@context": "http://schema.org", Financial risk. ", { OUTLINE What is Project Finance?How does project finance create value? Project Finance: Pre-completion risks: Resource, technological, timing, and completion risks. Debt financing for PDVSA more expensive under corporate finance structure: PDVSA has low credit rating (long-term senior unsecured debt rating B from S&P), thereby relatively high cost of debt ~ 10.17% (Exhibit 10b) Under project financing, if the project can secure BBB investment grade rating, lower cost of debt ~ 7.70% A gain of 2.47% However, huge transaction and contracting costs as well as the longer time needed to structure a project financed deal should be weighed against the potentially lower cost of debt to see if there is a net gain in terms of costs. Workers on strike held management hostage in Despite the ongoing strike, the project proceeded as planned, and was in fact on time and below budget. ", Similar references for the subcontractors. The terrain between the oil fields and the coast was relatively flat and sparsely populated, which would ease pipeline construction. Project finance is preferred when cost of risk contamination exceeds the benefits of co-insurance. "name": "Case examples to value creation", Sponsor-related risks (Lenders\u2019 perspective): Sponsor commitment to the project. "@type": "ImageObject", "contentUrl": "https://slideplayer.com/slide/5357710/17/images/96/Post-completion+risks+and+mitigation.jpg", "@context": "http://schema.org", The project with potentially high returns and developmental impact for Chad was also aligned with WB\u2019s policy objectives. Other equity investors to be selected would be high rated sponsors who were also capacity buyers. Involvement of multilateral/bilateral agencies, Unclear and/or inconsistent legal/regulatory framework for projects operations, Insufficient protection of private investment and private ownership/control of project, Changes in law, such as imposition of new environmental/health/safety requirements, price controls, import duties/controls, increase in taxes, royalties, deregulation, amendment or withdrawal of projects permits, changing the control of company, A general principle is that the party who is paying for the output under a project contract should pay for the losses incurred due to changes in law specific to the industry, because such change is reflected in the entire industry and any extra costs will normally be passed on to end users; therefore an offtaker who does not bear this risk would earn extra profits at the expense of the project company. The lead sponsor, Telstra, has to structure the project company, selecting an ownership, financial, and governance structure. Indian Institute of Management, Ahmedabad. ", When the benefits of above told co-insurance outweighs cost of risk contamination, Discrete, non-core assets that can be separated from the rest of the business) Example: power plants, Large, highly risky projects with cash flows highly correlated with those of sponsor (no benefits from diversification under one portfolio), Projects appropriate for high leverage (those with predictable cash flows, low distress costs, and minimal ongoing investment requirements), Projects that are more transparent and easier to monitor during construction, development, and ongoing operations (transparency can lower cost of capital by facilitating credit decisions), Projects with a structure that minimizes overall costs associated with market imperfections, When it is possible and cost effective to allocate the project risks contractually, Projects whose cash inflows and outflows can be set by long-term contracts (to reduce variability), For oil industry, production projects, rather than exploration or development: Banks generally reluctant to lend on project basis until the underlying stock/flow is proven and capable of production ( reducing variability and risk), High risk projects such as first-time investments in new industries, markets, technologies: project finance may bring added discipline and access to experienced partners, Projects exposed to high degree of sovereign/political risk may benefit from the existence of outside lenders in project finance structure: host governments cannot risk project due to potential reaction from international finance community, Project financing may help accommodating critical partners (such as governmental agencies) who cannot finance their shares via corporate borrowing (Joint venture projects), Project finance is preferred when it results in higher combined variance when added to corporate portfolio. Project was structured in the following way to ensure that an expropriation would have international consequences, and also lenders would be comfortable enough to participate in the project: Existence of international commercial partners: International suppliers: Power from Eskom of South Africa, alumina from an Australian supplier, technology from France, most of the other inputs (coke, petroleum, etc.) { Electricity accounted for 25% of production costs. }, 86 "@type": "ImageObject", Also, opportunities for vertical integration may be absent. Benefits of debt-based governance. Benefit from portfolio diversification is negative (risk is higher) when sponsor and project cash flows are strongly positively correlated. "@type": "ImageObject", Still chances are low, as Gov\u2019t would not probably want to jeopardize future capital inflows by risking its relations with WB and the rest of the financial community. Risk sharing contracts to increase correlation between revenue and some cost items: If there is an off-take contract, linking input supply price to it: Basing the product price under the off-take contract on the cost of the input supplies (more likely if input supply is a widely traded commodity like oil), Basing the input supply price to product price under the off-take contract: (more likely if the input is a specialized commodity, or if there is no off-take contract and risk is passed to the input supplier), Input supply risk: Uncertainty regarding the availability of the input supplies throughout the life of the project, If there is an off-take contract, linking the terms of the output contract with input supply contracts such as the length of contract, volume, or force majeure, If there is no off-take contract, making the input supply contract run for at least the term of debt, An input supply contract is off-take contract for the supplier, Organizational risks: Incentive problems relating to management or workers, Output or cost target related pay for workers, Operating risk: operating difficulties due to technology (being degraded or obsolescent), processes used, or incapacity of operator team leads to inefficiencies and insufficient cash flow, Operating/maintenance contracts to ensure operational efficiency, Allowances for service / upgrade built into equipment supply contracts, Insurance to guarantee minimum operating cash. "name": "Case examples to value creation", "description": "Risk of war: not completely eliminated. "contentUrl": "https://slideplayer.com/slide/5357710/17/images/22/Value+creation+by+organizational+structure%3A+Risk+Contamination.jpg", { "@context": "http://schema.org", "@type": "ImageObject", Corporate finance is preferred when it results in lower combined variance due to diversification (co-insurance). "description": "Highly leveraged project company with concentrated equity ownership. "name": "Value creation by contractual structure: Contracting and Project Finance to reduce cost of risk", Project assets\/liabilities, cash flows, and contracts are separated from those of the sponsors, conditional on what accounting rules permit. "@context": "http://schema.org", Using external law or jurisdiction. Alusaf was the subsidiary of the South Aftrican Gencor group, which was the world\u2019s fourth largest aluminum producer. Structural Solutions: Sponsor\u2019s under-investment in positive NPV projects when sponsor has: limited corporate debt capacity. Investment specific equity from foreign investors is either hard to get or expensive. Real options Shadow costs: In case WB is not involved in the project, it is likely that the Govt will go with Libya Temporary stop option if oil price drops Involvement of multilateral\/bilateral agencies: IFC: Almost totally reduces the risk of expropriation and default. Bonds with interest rates indexed to product sales price. Recap. "width": "800" Careful review of contractor\u2019s credit standing. { Can take various forms, such as Take or Pay Contract: The Offtake Contract for the input supplier, Provides the Project Company the security of input supplies on a pre-agreed pricing basis, The terms of the Input Supply Contract are usually crafted to match those of the Offtake Contract (such as input volume, length of contract, force majeure, etc. E.g. "contentUrl": "https://slideplayer.com/slide/5357710/17/images/70/Chad-Cameroon+Petroleum+Development+and+Pipeline+Project.jpg", { Avoidance of possible risk contamination. Financing the Mozal Project. Benefits of debt-based governance. Strong debt covenants allow better monitoring. Pakistan has a beta of 0. A large and well-capitalized company, BP Amoco tries to decide on the best way to finance its share in the $8 billion development project of Caspian oil fields, undertaken by a consortium of 11 companies. Sovereign risks Expropriation risks:Outright seizure of assets very unlikely: The scale of the project relative to the size of the poor economy (9% of GDP), combined with short-term survival concerns may be tempting for a shortsighted Govt to expropriate Govt wouldn't want to curb the investments, because they are interested in development Govt cannot afford an outright seizure, due to potential reactions from WB/IFC, as this would jeopardize the much needed future development funds Following a direct seizure, international suppliers may not be willing to work with the Govt, and Mozambique does not have local suppliers of the raw materials to go on with the business alone }, 72 ", "width": "800" "width": "800" "name": "The Country Risk Rating Model", Insufficient protection of private investment and private ownership\/control of project. ", "name": "How Does It Create Value", Australia-Japan Cable Structuring a Project Company: The project included a 12,500 km submarine telecommunications system between Australia and Japan via Guam at a cost of $ 520M. "name": "Case examples to value creation", Value creation by contractual structure: Sovereign risks:Solution Hyperinflation risk: Relative changes in the price of inputs and output may adversely affect the project Indexing the output price (in the long term sales contract) against the CPI and or industry price indices in the host country where the relevant costs are incurred (Indexing means increasing over time against agreed, published economic indices) Expropriation: Direct, diversion, creeping Governments breach of contract and court decisions Government guarantees or regulatory undertakings to cover taxes, royalites, prices, monopolies, etc. }, 46 "@context": "http://schema.org", "description": "Problems. "name": "INTRODUCTION TO PROJECT FINANCE", IFC\u2019s concerns are the size of the project, as well as the political risks of doing business in Mozambique. "@context": "http://schema.org", Some adverse impacts are either irreversible or extremely hard to fix. }, 81 Japanese Government seemed not likely to approve building of a new landing station. Enclave projects: If the project revenues are paid from a source outside the host country, the project can be insulated from foreign exchange and transfer risks (Example: sales of oil, gas across borders) Offshore debt service reserve accounts. "@type": "ImageObject", Project finance is preferred when cost of risk contamination exceeds the benefits of co-insurance. "@type": "ImageObject", "@type": "ImageObject", "name": "How Does It Create Value", Corporate financing probably also helped save both the costly delays at the development stage of the project and the structuring costs, which would be incurred in project financing. ExxonMobil was actually a huge portfolio of upstream businesses (exploration, development, production of crude oil and natural gas), downstream businesses (transportation, marketing, and sales), as well as chemical byproducts and operations in mining. "contentUrl": "https://slideplayer.com/slide/5357710/17/images/39/Value+creation+by+contractual+structure%3A+Sovereign+risks%3A.jpg", Sponsors planned a $75M contingency budget for the construction period, Mozal would use proven, state-of-the art smelting technology (Pechiney technology from France) that was used in the Hillside smelter, Both sponsors have significant experience in the smelting industry with Hillside being their most recent undertaking, Alusaf was the subsidiary of the South Aftrican Gencor group, which was the worlds fourth largest aluminum producer, The sponsors planned to purchase all of the output subject to long-term purchase agreements, but at market prices, The market prices had been declining for the last couple of years, and the trend was expected to continue due to the developing scrap market, Mozal would be a low cost producer in the industry (lowest 5% in terms of cost) , having higher margins than other players to absorb potential market price declines, Supply risk and operating costs: Availability, quality, and price of the alumina, electricity, and labor, Alumina accounted for 33% of production costs, The sponsors planned to link the price for alumina to LME aluminum market prices, Alumina would be imported from a supplier of Alusafs affiliated company Billiton under a 25 year supply contract, Electricity accounted for 25% of production costs, The electricity price would also be a function of aluminum prices, Eskom and Mozambican Electric company would provide inexpensive electricity under a 25 year contract whereby the price will be fixed in the early years and then tied to aluminum prices, The majority of unskilled labor would come from Mozambique, decreasing labor costs compared to industry averages, Other inputs would be supplied from the same contractors who supplied the Hillside smelter under similar long-term contracts. Close monitoring \/ testing of project execution (operational, financial, etc.) Chad might not gain on an incremental basis due to displacement of existing aid, and yet lose control on its single natural resource, Environmental and social risks mostly remain with Chad, Some adverse impacts are either irreversible or extremely hard to fix, Despite contingency plans, there may be leakages in the pipeline that would go unnoticed for long time, due to limitations of even the most advanced technologies, Less share of the gains in the upside (though balanced with the highest protection from downside risks), Although expected to be a highest priority issue from Chads perspective, the timing of cash flows were not negotiated to the advantage of Chad, Considering the urgent need for funds, the allocation of cash flows should have favored Chad more in the initial years, Compared to the timing of cash allocations for other sponsors, the late allocation might be perceived as unfair and might increase the chances of expropriation, The presence of WB/ECA/IFC along with participation on governments in equity financing significantly reduced political risk exposure, Project might have helped portfolio diversification, Low construction risks (sponsors expertise and reputation in the industry), Low operating risks (positive NPV under most scenarios in Exhibit 5 with different price and reserve levels), Low financial risks, considering the DSCR (as high as 2:1) and low breakeven finding and development costs compared to price, The presence of WB/ECA/IFC in the deal, alignment of Govt interests via equity ownership through project finance structure, the linking of installment of future development funds to Governments compliance to the RMP significantly reduced political risk exposure. "name": "Subjects of opposition:", "@context": "http://schema.org", "name": "Corporate financing for the field system:", "description": "Using high leverage: Ensures cash flows are kept low so that temptation for seizure is low. { ", ", "@type": "ImageObject", Background: Calpine, a small power generator with high leverage (~80%), sub-investment grade rating, and little debt capacity, has to decide how to finance its aggressive growth strategy, facing increasing pressure for speed, efficiency, and flexibility in a soon-to-be competitive commodity market. "contentUrl": "https://slideplayer.com/slide/5357710/17/images/92/Pre-completion+risks+and+mitigation.jpg", "width": "800" "@context": "http://schema.org", "name": "Financial risks and mitigation", Most assumptions of CAPM fail in this environment. "description": "How project structure may help: A hybrid structure was crafted that combined elements of both project and corporate finance: Project Finance: Calpine project financed a portfolio of plants rather than a single plant. Introduction to Derivatives and Risk Management Corporate Finance Dr. A. DeMaskey. Value creation by contractual structure: Sovereign risks:Solution Political risks: Likelihood of occurrence of political events like wars, labor strikes, terrorism, etc. { "description": "Project Finance: For oil industry, production projects, rather than exploration or development: Banks generally reluctant to lend on project basis until the underlying stock\/flow is proven and capable of production (\uf0e0 reducing variability and risk) High risk projects such as first-time investments in new industries, markets, technologies: project finance may bring added discipline and access to experienced partners. Political risk insurance. "width": "800" "@type": "ImageObject", "contentUrl": "https://slideplayer.com/slide/5357710/17/images/117/Sovereign+risks+mitigation.jpg", Alumina accounted for 33% of production costs. Similarly, the South African ECA may be more willing to bear the political risk than banks do because it attaches a higher value to the project in order to be able to promote the south African exports. Assuming production level of 120,000 BPCD and 35 years project life, 7% of these reserves is sufficient to sustain the project Variability in the available crude oils quality was not deemed to be significant to reduce the efficiency of upgraders Additional value creation for Conoco from corporate perspective: In addition to being an equity holder in the project, Conoco would also benefit from low-cost reserves and long-run supply of crude oil the project would provide (with off-take contracts) for its refinery business "name": "The role of IFC Appraising the project", "@type": "ImageObject", "contentUrl": "https://slideplayer.com/slide/5357710/17/images/80/Assessment+of+Project+Risks+and+Returns%3A+Chad.jpg", Project financing for the export system mainly enabled the sponsors to spread the political risks as much as possible via the presence of outside lenders such as WB, IFC, ECAs. ", "name": "Pre-completion risks and mitigation", "name": "Sovereign risks and mitigation", "contentUrl": "https://slideplayer.com/slide/5357710/17/images/84/Project+Update+After+WB+approved+the+deal%2C+President+Deby+used+part+of+the+proceeds+to+buy+weapons..jpg", Supply risk: Uncertainty regarding the availability of the input supplies throughout the life of the project. When firm value decreases due to cost of financial distress which increases with combined variance. In December 2005, the National Assembly of Chad amended the countrys Petroleum Revenue Management Law in the following ways*: broadening the definition of priority sectors to include, among other areas, territorial administration and security; and by allowing that further changes in the definition of priority sectors can be made by decree; eliminating the Future Generations Fund, thus allowing the transfer of more than US$36 million already accumulated there to the general budget , increasing from 13.5 % to 30% the share of royalties and dividends that can be allocated to non-priority sectors that are not subject to oversight and control, * Chad-Cameroon Pipeline Project, World Bank Web Site. }, 2 }, 101 Indexing the output price (in the long term sales contract) against the CPI and or industry price indices in the host country where the relevant costs are incurred (Indexing means increasing over time against agreed, published economic indices) Expropriation: Direct, diversion, creeping. "description": "Supply risk and operating costs: Availability, quality, and price of the alumina, electricity, and labor. Engineering, Procurement, Construction (EPC) Contract) Operation and Maintenance Contracts: Ensures that the operating and maintenance costs stay within budget, and project operates as planned. Project design itself for risk mitigation (elements of production process, technology used, etc.) "description": "Issues: Selection of strategic sponsors who would bring the most value to the project. "@type": "ImageObject", Agency costs, debt overhang, risk contamination, risk mitigation. ", "description": "Completed a $1B bond issue, which was five times oversubscribed, and a total of $450M bank financing (with 14 years maturity at 7.98%, 12 years maturity at 7.86%) The project considered by analysts as one of the best structured and best executed project finance deals ever done , PDVSA continued to structure deals for the Orinoco Basin. "description": "Option to delay the project. "@type": "ImageObject", Besides, the project structure was designed in such a way to allow for higher interest payments when sales increase, minimizing the cash balances. "@type": "ImageObject", "contentUrl": "https://slideplayer.com/slide/5357710/17/images/2/OUTLINE+What+is+Project+Finance.jpg", "contentUrl": "https://slideplayer.com/slide/5357710/17/images/125/Recap+-+Type+of+assets%2Fprojects+and+appropriate+method+of+financing%3A.jpg", }, 82 When the sponsor has strong balance sheet to secure debt in favorable terms, and a vertically integrated business model (which minimizes variability) When the sponsor is better equipped than anyone else in assessing and bearing risks. Assessment of project risks and returns. "name": "Chad-Cameroon Petroleum Development and Pipeline Project", "name": "Sovereign risks and mitigation", }, 75 Involvement of multilateral agencies (WB/IFC) (structuring legal/financial documents, mediation in negotiations, sovereign deterrence, halo effect), Bilateral agencies: Export credits from ECAs (who provide PRI), Contractual sharing of political risks between sponsors and lenders, Match term of loan to productive life of assets, Match repayment schedule to expected cash flows, Bonds with interest rates indexed to product sales price, Match currency of loans to currency of revenues, Tighter covenants limit managerial discretion and enforces greater discipline via better monitoring, High leverage reduces free cash flow exposed to discretion, High leverage also reduces accounting profits thereby reducing the potential of local opposition to the company, Costs and benefits of debt-based governance. "width": "800" Project financing for a field development project would also not be a viable financing option, as the lenders generally would be reluctant to finance until after all reserves are proven and capable of production.
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