"width": "800" }, 104 Each of the partners had a choice in how to finance its share of the total investment. The credit rating may proxy for many of these fundamental risks as it is survey based. Environmental\/social concerns seem to be well addressed in contingency plans with extensive public consultation. Considering the urgent need for funds, the allocation of cash flows should have favored Chad more in the initial years. }, 36 Option to sell the excess capacity to future projects in the area. }, 42 Variability in RHS variables lead to changes in return to equity. Project Update WB considered these changes a breach of contract, and on January, 2006, it suspended new loans and grants to Chad, as well as disbursements under eight ongoing IDA operations in the country. Receive up to $125M per year from the project, increasing Gov\u2019t revenues by more than 50% Chad has few other alternatives if any for development. "description": "Problems. The Country Risk Rating ModelCost of Capital = risk free + intercept (slope x Log(IICCR)) Log(IICCR) is the natural logarithm of the Institutional Investor Country Credit Rating Gives the cost of capital of an average project in the country in $). "name": "OUTLINE What is Project Finance", Real Options value of flexibilityOption to delay the project Option to increase the production Option to sell the excess capacity to future projects in the area Option to abandon the project, since the project consists of several stages { The sponsors decide on 60% debt financing, and seek for alternative ways to raise the required funds. Differing information or predictions regarding future. { "@context": "http://schema.org",

Real options: Design flexibility into project to allow for responses of new information or market changes. Besides, the vertically integrated business model made it a naturally cost-efficient choice for ExxonMobil to hold the assets collectively with corporate financing rather than individually with project financing. "description": "Besides direct investment through A loans, it mobilized other funding sources like ECA and other banks through a syndicated B loan. ", Assuming production level of 120,000 BPCD and 35 years project life, 7% of these reserves is sufficient to sustain the project. Structuring the legal\/financial documents. "@context": "http://schema.org", Also, opportunities for vertical integration may be absent. Given the projects are defined within narrow boundaries with limited investment opportunities, moral hazard (risk shifting, debt shifting, reluctance to invest) is minimized. Failure to meet completion criteria would make all non-recourse debt due and payable. "description": "How are costs of risk reduced Some risks can be reduced by spreading the burden across many participants; some other risks cannot be spread, but can be shifted or reallocated. }, 123 Assessment of Project Risks and Returns: ChadThe realization of the opportunity for economic development strictly dependent on Governments commitment in implementation of RMP RMP is claimed to lack credible oversight and enforcement mechanisms, which would work against the people of Chad due to undemocratic and oppressive Govt in power RMP was a concept yet to be tested with the project; even WB admitted the project to be an experiment, which increases peoples exposure to risk Chad has to put its only natural resource into the project under project finance structure and RMP, which considerably eliminates sovereign discretion and flexibility Impositions on the allocation of revenues may turn out to be constraining for a future democratic government who wants to implement other projects to the benefit of people of Chad Governments compliance to RMP is a requirement for future WB loans, which extends the potential influence of the project-specific impositions and commitments to non-project specific areas, increasing Chads exposure to risks

power, roads), technology transfer, creating permanent employment opportunities (873 jobs) and 5000 construction jobs as well as human capacity building. 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. Allowances for service \/ upgrade built into equipment supply contracts. Investment specific equity from foreign investors is either hard to get or expensive. "@context": "http://schema.org",

Serious inflation levels that reached 100% in", "@type": "ImageObject", "@context": "http://schema.org", "width": "800" }, 35 "description": "Structural decisions may affect the existence and magnitude of costs due to market perfections: * Agency conflicts. Government guarantees or regulatory undertakings to cover taxes, royalites, prices, monopolies, etc. { The pipelines would run 125 miles between the oil fields and the coast, increasing risk exposure. Is it also one of project\u2019s sponsors (Conflict of interest) Contract supervision by the project company\u2019s other personnel not directly related to the contractor. "name": "Value creation by contractual structure: An Introduction to Risk Management", Performance warranties on equipment. 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. "contentUrl": "https://slideplayer.com/slide/5357710/17/images/125/Recap+-+Type+of+assets%2Fprojects+and+appropriate+method+of+financing%3A.jpg", Value creation by organizational structure: Risk ContaminationProblems Structural Solutions: A high risk project may potentially drag a healthy sponsor into distress, by increasing cash flow volatility and reducing firm value. }, 21 Helps uncover the information about the project, as well as sponsors and governments involved, which may not be readily available to lenders, Acts as a mediator between the governments and sponsors to ensure all issues are addressed and handled properly, Better qualified to do sovereign risk analysis given its development experience and relationships with governments, Significant difference between ex-ante and ex-post economic and financial return calculations, Structuring the legal/financial documents, Has a reputation for being an honest broker, Significant experience in mediating large and diverse groups and resolving complex legal issues, Instrumental in harmonizing the legal structures of Mozambique and South Africa to create an agreed-upon basis for dispute resolutions. Risk management Identification and mitigation of:Pre-completion risks: Resource, technological, timing, and completion risks Post-completion risks: Market risk, supply risk, throughput risk, and force majeure Sovereign risks: Inflation risk, exchange rate volatility convertibility risk, expropriation Financial risks: Leverage risk under the constraint of investment grade rating Operation risks. Free floating of the Bolivar against $ may result in appreciation of the currency, leading to increased local costs and tax liabilities. Recap. "@context": "http://schema.org", "@type": "ImageObject", E.g. TOPICS 1. "@type": "ImageObject", ",

As much as IFC involvement was the critical issue, securing political risk insurance was important as well to provide comfort to potential lenders: Political risk insurance is an instrument to help shift (not mitigate) the political risks (like expropriation, war, breach of contract, or currency inconvertibility) to parties that are best able to bear it, PRI providers generally have a more diversified portfolio than banks to absorb these risks, PRI providers are more competent in analyzing sovereign risks, whereas commercial banks in analyzing commercial risks, A French ECA supporting the use of the French technology was expected to provide 85% insurance for loans from French banks, and IDC was in advance discussions with the South African ECA for insurance for $400 M senior debt, The French 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 export the technology, 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. Value creation by Project Finance. Case examples to value creationHow project structure may help: Contemplated on concentrated equity ownership to maintain more effective management and monitoring As for an interim management team, sponsors would also be made equal partners in control, regardless of individual ownership shares 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 Single cash flow easier to monitor "name": "Value creation by contractual structure: An Introduction to Risk Management", "width": "800" "@type": "ImageObject", Government Support Agreement: Government guarantee of foreign exchange availability: However, if the host country gets into financial difficulty and runs out of foreign currency reserves, then the government may forbid either the conversion of local currency amounts to foreign currency, or the transmission of these amounts abroad \uf0e0 The support agreement may become invalid. "contentUrl": "https://slideplayer.com/slide/5357710/17/images/72/Corporate+financing+for+the+field+system%3A.jpg", "@context": "http://schema.org", Careful review of the project scale in relation to the size of contractor\u2019s overall business. The crude oil prices for the last 18 months ranged from $9 to $42, averaging $20 per barrel, which, even after discounted for the lower grade, was considerably higher than the projects $5.20 exploration and development costs. "@type": "ImageObject", "width": "800" Conversely, a failing sponsor can drag a healthy project along with itself. ", Debt may be the only option and project finance the optimal structure. Sponsors dependent on cash generated during start-up for funding $34M of the project. { Real options. Single cash flow stream and separate ownership provides easier monitoring. "contentUrl": "https://slideplayer.com/slide/5357710/17/images/7/Major+characteristics%3A.jpg", "@type": "ImageObject", "name": "Value creation by contractual structure: Post-completion risks:", Modern Project Finance: A Casebook, Benjamin Esty, John Wiley & Sons, Principles of Project Finance, E.R. }, 43 "name": "Recap - Type of assets\/projects and appropriate method of financing:", Costs: Time consuming and expensive to set-up and execute individual deals. "@type": "ImageObject", { "width": "800" "contentUrl": "https://slideplayer.com/slide/5357710/17/images/74/Project+financing+for+the+export+system%3A.jpg", "name": "Case examples to value creation", Organizational structure. If the third party is not otherwise involved in the project, incentive mechanisms to keep the timetable, If the third party is involved with a project contract, the contract should include terms such that the third party should be held responsible for the delay losses, Contractors good relationships and experience with the third parties may be a plus, Financing the projects as one package may be examined as a potential solution, as long as the sponsors interests on both sides can be aligned. "contentUrl": "https://slideplayer.com/slide/5357710/17/images/26/Value+creation+by+contractual+structure%3A+An+Introduction+to+Risk+Management.jpg", "@context": "http://schema.org", "description": "Outright seizure of assets \u2013 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 Gov\u2019t to expropriate. Background Projects are characterized by: unique riskshigh and rapidly changing leverage imbedded flexibility to respond to changing conditions (real options) changing tax rates early, certain and large negative cash flows followed by uncertain positive cash flows Traditional DCF method is inaccurate: Single discount rate does not account for changing leverage Ignores imbedded options Idiosyncratic risks are usually incorporated in the discount rate as a fudge factor Traditional CAPM method is inaccurate: Many mega projects are in emerging markets Many of these markets do not have mature equity markets. PRI providers generally have a more diversified portfolio than banks to absorb these risks. "@context": "http://schema.org", { bank loans vs. bonds) to facilitate the restructuring and speedy resolutions. Project financed investment exposes the sponsor to losses only to the extent of its equity commitment, thereby reducing its distress costs Through project financing, sponsors can share project risk with other sponsors: Pooling of capital reduces each providers distress cost due to the relatively smaller size of the investment and therefore the overall distress costs are reduced.

Nonperformance on completion: due to poor design, inadequate technology. "name": "How Does It Create Value", "width": "800" In simple terms, Return to equity = Revenues Material / service costs Labor costs Depreciation Interest expenses Taxes Variability in RHS variables lead to changes in return to equity Other earners of net income (or net value added) from investment can also share risk: Net Value added = Return to equity + Interest expenses + Taxes + Labor costs = Revenues Material / service costs Depreciation Profit sharing mechanisms or tax incentives may change how variability in income is shared among sponsors, lenders, government, and labor Output purchasers and input suppliers can also share the risks as they experience variability in their markets Project finance is preferred when cost of risk contamination exceeds the benefits of co-insurance. Mozal is a $1.4 B aluminum smelter project in Mozambique. "name": "Major project contracts:", (Conflict of interest), Contract supervision by the project companys other personnel not directly related to the contractor, The contractors credit standing? A hybrid structure was crafted that combined elements of both project and corporate finance: Calpine project financed a portfolio of plants rather than a single plant. Confusing bond and equity risk premia. 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. Site acquisition and access, permits. Social programs planned for Mozambican people. "contentUrl": "https://slideplayer.com/slide/5357710/17/images/63/Approaches+to+calculating+the+Cost+of+Capital+in+Emerging+Markets.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. "@type": "ImageObject", Value creation by contractual structure: Sovereign risks:Solution Exchange rate changes: Uncertainty regarding the changes in the exchange rate throughout the life of the project Implications of a sudden major local currency devaluation in cases where the project revenue is in local currency and debt in foreign currency Revenues, costs, and debt in same currency (indexing if they are not in the same currency) Market-based hedging of currency risks (though not widely used) For protection from a sudden major devaluation, a revolving liquidity facility can be utilized to cover the time lapse between the devaluation and the subsequent increase in inflation that should compensate the project company for debt payments Currency convertibility / transferability risk: As it is often not possible to raise funding in local currency in developing countries, revenues earned in local currencies need to be converted into foreign currency amounts needed by offshore investors/lenders, and then need to be transferred outside the country to pay for them. "@type": "ImageObject", "width": "800" { }, 127 Structural Solutions: Concentrated equity ownership and single cash flow stream provides critical monitoring. "@type": "ImageObject",

The alternatives BP Amoco considered for its share were corporate financing, project financing, or a hybrid structure. "@context": "http://schema.org", "@type": "ImageObject",

The Beta with the World portfolio is not indicative of the sovereign risk of the country (asymmetric downside risks). bank loans vs. bonds) to facilitate the restructuring and speedy resolutions Usually subordinated debt (quasi equity) is provided by sponsors Strong debt covenants allow better monitoring Single cash flow stream and separate ownership provides easier monitoring The Govt would not want to forego serious amount of revenues in the form of dividends, taxes, royalties. { An undertaking to pay a long-run average price. }, 18 "width": "800" Value creation by contractual structure: Financial risks:Solution Default risk: Ensure sufficient debt service coverage Decrease debt/equity ratio 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 Interest rate risk: Interest rate swaps and hedging Interest rate caps Finance jointly with corporate funds? Capacity agreements with high rated sponsors would also be instrumental in raising debt with favorable conditions. "width": "800" Force majeure risk: Likelihood of occurrence of events like wars, labor strikes, terrorism, or nonpolitical events such as earthquakes, etc. ", "name": "Financial risks and mitigation", "description": "Problems. "description": "Solution. "contentUrl": "https://slideplayer.com/slide/5357710/17/images/11/Major+project+contracts%3A.jpg", }, 98 Project financing and corporate financing alternatives are considered. "@context": "http://schema.org", ", "@type": "ImageObject", "@type": "ImageObject", "name": "Major characteristics:", { Gov\u2019t wouldn t want to curb the investments, because they are interested in development. "contentUrl": "https://slideplayer.com/slide/5357710/17/images/108/Background.jpg", Case analyses Chad-Cameroon Petroleum Development and Pipeline ProjectPetrozuata and Oil Field Development Project Financing the Mozal Project Impositions on the allocation of revenues may turn out to be constraining for a future democratic government who wants to implement other projects to the benefit of people of Chad. Project finance is preferred when cost of risk contamination exceeds the benefits of co-insurance. * Structuring and executing transactions. When it is possible and cost effective to allocate the project risks contractually. Major characteristics:Highly leveraged project company with concentrated equity ownership Partly due to firms need for flexibility and excess debt capacity to invest in attractive opportunities whenever they arise Syndicate of banks and/or financial institutions provide debt Typical D/V ratio as high as 70% and above Debt has higher spreads than corporate debt One to three equity sponsors Sponsors provide capital in the form of equity or quasi-equity (subordinated debt) Governing Board comprises of mainly affiliated directors from sponsors "contentUrl": "https://slideplayer.com/slide/5357710/17/images/85/Project+Update.jpg", Bank debt with a small banking group was preferred rather than project bonds to have flexibility. Require lower D\/E ratio. 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. Value creation by contractual structure: Contracting and Project Finance to reduce cost of riskGenerally well developed capital, financial, and futures markets may not always be available Special contractual arrangements are often required to manage risk to make projects viable The aim of extensive contracting is to reduce cash flow volatility, increase firm value and debt capacity in a cost-effective way Guarantees and insurance for those risks that cannot be handled through contracting Elements of contracting: General form: Exchange risk (x) for return (y) Additional considerations: Participation or partial transfer of ownership Timing of x and y Contingency of x and y (under what circumstances) Penalties on non-performance Bonus on performance "@context": "http://schema.org", Exchange rate changes: Uncertainty regarding the changes in the exchange rate throughout the life of the project. price or volume risk) compared to corporate sponsors, probably because bulk of the revenues (royalties) independent from price or reserve levels. "contentUrl": "https://slideplayer.com/slide/5357710/17/images/86/Petrozuata+and+Oil+Field+Development+Project.jpg", Necessity to be a low-cost producer in a commodity market. "name": "Value creation by organizational structure: Agency Costs", "@type": "ImageObject", { The project is a complex one consisting of multiple components including field facilities, pipeline system, and the upgrader facilities. "@context": "http://schema.org", Very large projects can potentially destroy the sponsors balance sheet and lead to managerial risk aversion. "@context": "http://schema.org", Success in this project will be a proof of concept for the rest. Strategic reasons in the long run: $2.4B Petrozuata will be the first in a series of projects planned which total as high as $65 B. PDVSA needs to preserve debt capacity for future funding needs. High leverage reduces free cash flow exposed to discretion. History of nationalization in the 1970s. Alusaf was the subsidiary of the South Aftrican Gencor group, which was the world\u2019s fourth largest aluminum producer. ", Through project financing, sponsors can share project risk with other sponsors: Pooling of capital reduces each provider\u2019s distress cost due to the relatively smaller size of the investment and therefore the overall distress costs are reduced. High leverage reduces expropriation risk.

Project output syncrude has a narrow market limiting Government\u2019s motivation for a diversion attempt. { "@context": "http://schema.org", Instrumental in facilitating creation of common legal terms for critical issues like completion guarantees, which all parties agree to abide by. Effective contracts may provide: Better risk shifting: better distributions of cost. Tested technology. ",

The fact that non-recourse debt is backed by project assets\/cash flows and not by the sponsor\u2019s balance sheet increases the chances of an already highly leveraged sponsor to separately finance a viable project. "@type": "ImageObject", "name": "Value creation by contractual structure: Sovereign risks:", "description": "How project structure may help: Contemplated on concentrated equity ownership to maintain more effective management and monitoring. "contentUrl": "https://slideplayer.com/slide/5357710/17/images/106/What+happened+The+project+received+ratings+that+exceeded+the+sovereign+ratings+by+five+notches..jpg", "contentUrl": "https://slideplayer.com/slide/5357710/17/images/96/Post-completion+risks+and+mitigation.jpg", However these agencies only lend to stand alone projects. "contentUrl": "https://slideplayer.com/slide/5357710/17/images/50/Case+examples+to+value+creation.jpg", "@type": "ImageObject", Profit sharing \/ stock options. that constitute the field system Risks related to contractor: Is it competent to do the work Reputation, references for similar projects and technology being used. ", ", Accommodating the financially weaker partners in the consortium to negotiate better deals with creditors for the sake of future managerial and operational flexibility. Post-completion risks and mitigationTechnological risk: How proven is the technology used? Cost of capital calculation. The role of World Bank: WB involvement assured sponsors the much needed protection against the political risk Besides direct investment through A loans, it mobilized other funding sources like ECA and other banks through a syndicated B loan WBs extensive lending and policy experience with Chad offered the leverage that sponsors did not have The project with potentially high returns and developmental impact for Chad was also aligned with WBs policy objectives WB facilitated extensive consultation process including supporters and opponents: The process helped sponsors restructuring the project to minimize the social and environmental impact (such as increasing the benefits to indigenous people and changing the pipeline route to protect the natural habitat) WB also initiated a Revenue Management Plan to help prevent probable misuse of Chads revenues by the Govt, and target them for developmental purposes to increase welfare Insisted on an open and transparent project planning process Established capacity building programs to develop the infrastructure for a well-functioning petroleum industry and investment climate in both Chad and Cameroon