Project Finance versus Corporate Finance Opportunities in Oil&Gas Industry
Q1: Why Project Finance in Oil&Gas Industry?
Q2: Why Project Financing represents an OPPORTUNITY?
Several major reasons
Despite limited opportunities so far in the Romanian economy, the needs and potential are important Oil & Gas sector, and energy sector as complement, are special targets for these specific financings Both the complexity of financing and the technicality needed, provide opportunities for many types of companies: companies investing in Oil & Gas sector, design companies, companies providing specific equipments, technical / engineering consulting companies, construction companies, legal advisors, insurers and banking partners (19 types of participants) These projects offer long-term predictability of business, so again opportunities Because we have the necessary expertise to provide financial advisory and banking financing on this segment
Q1: Why Project Finance in Oil&Gas Industry? A1: because Oil&Gas sector has specific features for Project Finance Q2: Why Project Financing represents an OPPORTUNITY? A2: because risk allocation in such structured transaction is a business opportunity
Introduction
Project financing has become a major factor in the provision of MT and LT finance for new capital developments. It has underpinned many buy-outs of companies and assets, and is seen as a method of lending against a controllable and predictable cash flow.
There are many definitions of the project finance: A funding structure that relies on future cash flows from a specific development as the primary source of repayment, with that development’s assets, rights, and interests held as collateral security. Usually the recourse on the sponsor of the project company is limited. Project needs to be well defined conceptually and contractually.
What do we mean by a Project?
Investment made by a sponsor (a company or a jointjoint-venture) In a long term project/concession, which is either greenfield development or a sizeable increase in capacity or significant refurbishment/extension refurbishment/extension of an existing plant Which will generate a well defined stable cashcash-flow
The general form of project finance is three-stepped
First step – Funding to construct the project Second step – Completion of the project Third step – Project’s cash flow
The general form of project finance is three-stepped
First step – Funding to construct the project
The first step is the provision of funding to construct the project.
Funding is provided progressively under a bank project financing where drawdown procedures / rigorously test that the money has been spent.
The convention is to capitalize the interest charges into the loan precompletion (because there is no cash flow yet from the project).
Alternatively, a construction loan will be designed with a take-out at completion. A construction loan, therefore, is never a project financing.
The general form of project finance is three-stepped Second step – Completion of the project The second step is completion of the project. At the end of the commissioning period, successful completion is measured by a
.
This objective test measures whether the project has been built on time and at budget and is capable of producing the cash flow that was originally projected during the loan application phase. Until this test is satisfied, there will be: Careful allocation of funding from debt and equity; and Recourse to some creditworthy entity to cover any overruns, delays or cash flow/performance deficiencies. Once the completion test has been satisfied (or as in the case of an acquisition, a project is already producing cash flow), then the true project financing commences.
The general form of project finance is three-stepped
Third step – Project’s cash flow
In this third step, the project’s cash flows are used for debt service and recourse is limited to those cash flows and collateral security.
A number of projects have not been able to meet the completion test and thus never became project financings.
Components of project finance
Five components of project finance:
Cash flow predictions derived from technical, financial and market studies Risk allocation agreements through the project contracts and financing agreements Funding and repayment mechanism Legal security and provision to handle default/workouts Project reporting and compliance.
Types of PROJECT FINANCE There are six types of project financing that can be distinguished either by the method of repayment or the character of the funding: Straight project financing • where the sponsors guarantee completion Production loans • where principal repayment is linked directly to output, often CCY/unit basis Co-financings • where different funding sources provide project finance under one set of docs Complementary financings • where the funding is accomplished by parallel documentation Non-recourse • where is no further recourse on sponsors; structured as precompletion through a turn-key construction contract Limited recourse • where recourse is limited to an amount or subject to certain project performance criteria
MISCONCEPTIONS Project finance is subject to a number of widely held misconceptions, misconceptions, including the following: • Project financing is always offoff-balance sheet There is a great deal of confusion between the riskrisk-sharing nature of project financing and the balance sheet treatment which is a matter of accountants. Some varieties varieties of project financings are recorded on the balance sheet as a longlong-term item, while others are simply mentioned in the notes accompanying the financial statements. The main offoff-balance sheet tool is to deconsolidate by holding 2020-50% or less equity in the SPV or project borrowing company. • Lenders absorb all the risks, including political risk, during the the construction and the project finance stage Some country risk exposure may be available from lenders, but but political risk insurance and cocofinancing with multilateral agencies will more often be required. required. • Project finance is 100% debt In some cases this is possible due to very strong cash flows or high sunk equity. However, substantial equity commitment from sponsor is seen as an integral integral part of risks being shared. • Project financiers and sponsors share the risk of default This is rarely the case because its senior legal security position position will provide priority repayment and even operating rights to the project financier. • All project financings are nonnon-recourse Very few projects are nonnon-recourse, because additional supports are required, although turn turn-key construction contracts can get most of the way of nonnon-recourse. There will always be recourse in the event of fraud or false representation or warranties.
What is the difference between project and corporate finance? Corporate finance
• Internal cash flow generation • Raise equity • Bonds • Loans
• Bank is financing a corporate to do a project • Financial analysis of the company • Specific documentation / LMA or bilateral docs
Project finance
• Equity • Quasi equity • Loans (limited recourse)
• Bank is financing a project and not the sponsors developing the project • Nature of project cash flows / certainty of cash flow • Credit rating of major project counterparties > Credit intensive: with 19 possible participants • Highly structural: risk allocation makes for rigorous structuring among the parties involved • Margins: project financing is highly competitive and margins are low relative to the risk assumed by the project financiers • Project’ Project’s risk evaluation / risk allocation
Difference: An asset-based financing or financing of a project with financial recourse to a company’s balance sheet or with the benefit of a financial guarantee from a parent company or a government is not regarded as a project financing.
13
Sectors The suitability of project financing to a particular industry sector is a direct function of the predictability of the future cash flows, either from the economics of the industry or the commercial relationship customary to that sector.
Sectorial features for project finance: ◘ Reliance on OPEX competitiveness: oil&gas, mining ◘ Insulation from market and supply risks (nature of tolling): power, oil&gas, ports ◘ Long term off-take contracts: power, oil& gas, water, waste management ◘ Monopoly/concessionaire provisions (revenues protection): oil&gas/pipelines, telecom, infrastructure
Difficult sectors for project finance: > market risk: industrial minerals, pulp/paper; low barrier: pharma, manufacturing, cement; technology dependent: computers, tertiary oil; short life products (software, electronics); environmental risks: second hand plants; asset driven: aircraft, property, real estate
Opportunities in project finance Why are opportunities in project finance?
With 19 possible participants, 6 basic types and 16 risks to evaluate/allocate, project financing is a multi-disciplinary business opportunity. Potentially there are 19 participants in a project financing (and the next figure shows relationships for a typical build-own-operate co-generation power plant. Each type of participant will have his own agenda and objectives.
Participants 1.
Sponsors The sponsors are providing: technology, operations management, construction, financial clout, supply/resources and/or off-take. Objectives of sponsors: shed risk to lenders (e.g. political risk); project too large; isolate a project; non-recourse; new sector; greater debt/equity, higher leverage; funding sources; off-balance sheet.
2.
The borrower Many project financings are structured with a special-purpose entity or borrowing vehicle that gathers support from sponsors pre-completion. Post-completion it becomes the sole borrower of the project financing. This is the key means of isolating recourse to the sponsors postcompletion.
3. Financial advisers Banks, ECA’s/country risk specialists, financial analysts, accounting firms, law firms, brokers.
Participants in project finance / continued 4. Arrangers/lead underwriters (arranger/managers, co-lead/co-managers, agent bank/documentation, technical bank, cash flow modeler, etc) 5. ECAs/Multilateral banks: players that can provide co-financings or complementary financings, or buyer credit/supplier credits. 6. Agent/trustee: in some cases a separate entity is charged with the responsibility of managing the documentation, bank accounts and the reserve account provisioning. 7. Lessors 8. Independent experts: market, engineering, environmental, tax, accounting, reserves, traffic/supply. 9. Lawyers 10. Governments
Participants in project finance / continued 11. Construction contractors: engineering, design, procurement, construction, management of construction, completion/commissioning. 12. O&M companies: managing during commissioning or after completion (performance guarantees providers) 13. Insurers : brokers/advisers or insurance companies (packages during construction, business interruption /post-completion, environmental, statutory insurances, etc) 14. Swap counterparties 15. Suppliers 16. Equipments vendors 17. Off-takers 18. Transportation companies 19. Rating agencies
Project finance participants
Risk sharing The main attraction of project financing is the ability to pass on certain risks to the lenders, although this has a perceived cost (risk premium) and lengthens the negotiating process. Every major risk presented by a certain project is allocated to the party that is best able to appraise and control that risk. Opportunities: to use project finance to isolate a specific project from the ongoing business of the company and thereby not jeopardize the debt capacity of the organization; project financing is where more than one project is being developed at the same time; where a project financing is arranged from an existing venture to generate acquisition funds or even develop another project; a project finance could first be arranged from one enterprise to develop a second and, a few years later, the first two refinanced to develop a third – i.e. sequential project financings building up a portfolio. The ability to identify and quantify the risks in a project financing is pivotal to any understanding of the business. Risks can be mitigated by: financial, contractual or legal means. Part of them may be sufficiently well studied or accepted. The project developer may have a track record dealing with particular risk.
Risks impact on cash flow
Risk category / cash flow category
Covering the key risks
Let’s complete together this LIST !
There are ongoing projects and, most significantly, important potential ahead. ◘ pipelines ◘ underground gas storage (greenfield or brown field) ◘ cogeneration power plants (greenfield or brown field) ◘ on-shore/off-shore oil terminals ◘ LPG/LNG terminals ◘ energy efficiency oil&gas related projects ◘ the others to be discovered together
Global Sector Share 1 H 2009 (1H 2008) Source: DEALOGIC GLOBAL PROJECT FINANCE REVIEW, H1 2009
Project Finance - Rankings & Volume H1 2009 Source: DEALOGIC GLOBAL PROJECT FINANCE REVIEW, H1 2009
BRD Groupe Societe Generale is ready to successfully structure for you project financing and any other kinds of debt. We understand the way the companies and the Oil&Gas Industry operates and we have the necessary insight for debt funding and operations.
Our structuring capabilities, Oil&Gas Industry experience and access to the capital markets enables BRD to offer project finance, maybe the
next tool for your company's development and growth.
Petroleum Club
THANK YOU ! Grigore PANA [email protected]
