Project Finance

PF- 2

Topics

¾What is Project Finance?

¾Examples of Projects
¾Project Finance Advantages and Disadvantages
¾Infrastructure Public-Private Partnerships
 PF- 3

What is Project Finance?

Project finance may be defined as the

raising of funds to finance an
economically separable capital investment
project, in which the providers of funds
look primarily to the cash flow from the
project to service their loans and provide a
return on the equity invested.
 PF- 4

What is Project Finance?

¾Project Financing can be arranged when a
particular facility or related set of assets is
capable of functioning profitably as an
independent economic unit (Finnerty, 1996)
¾This independent economic unit involves
the issuance of equity securities (for the
sponsors of the project) and of debt
securities that are designed to be self-
liquidating from the revenues derived from
project operations.
 PF- 5

What is Project Finance?

The project is a legal entity (Special Purpose

Corporation).
Examples: Pipelines, oil drilling projects,
refineries, electricity generating facilities,
hydroelectric projects, dock facilities, mines,
mineral processing facilities, highways and
bridges.
Project is a nexus of agreements among
financially responsible parties.
 PF- 6

What is PF?
 PF- 7

What is Project Finance?

Lenders
Loan funds,
Debt
repayment

Suppliers Purchasers
Raw Output,
materials, Project Purchase
Supply contracts
contracts
Assets

Investors/Sponsors
Credit support, Cash
Equity Investors
deficiency agreement
Equity funds,
Returns
 PF- 8

What is Project Finance?

¾Project financing can be beneficial to a
company with a proposed project when:
– The project’s output would be in such strong
demand that purchasers would be willing to
enter into long-term purchase contracts, and
– The contracts would have strong enough
provisions that banks would be willing to
advance funds to finance construction on the
basis of the contracts
 PF- 9

What is Project Finance?

Example

USA, PURPA, 1978. Small scale electricity producers.

The project is a cogeneration plant. Produces steam to

generate electricity. The project owners may use some of the
electricity produced and sell the rest to the local electric
utility company. Leftover heat is used for a chemical plant.

The project sponsor is Engineering Co., which has

experience in constructing and managing energy facilities.
Fixed-price, turn-key contract.
 PF- 10

What is Project Finance?

The industrial user is Chemical Co. that agrees to purchase
steam for the next 15 years.

The local Utility Co. provides gas and electricity to area

customers. It agrees to supply gas and purchase electricity
from the project for the next 15 years.

Institutional equity investors and lenders will supply the

rest of funding.
 PF- 11

What is Project Finance?

 PF- 12

Requirements of PF
¾Technical feasibility
– Sponsors undertake extensive engineering work
to verify the technological processes and design
of proposed facility
– This provides the basis for estimating the
construction costs for the project
– Contingency factors to cover possible design
errors or unforeseen costs
 PF- 13

Requirements of PF
¾Economic viability
– Marketability of project’s output (price and
volume)
– Projections of operating cost
– Determination of project’s cost of capital
– Adequacy of raw material supplies
¾Creditworthiness
– Inherent value of project assets
– Expected profitability of the project
– Amount of equity project sponsors have at risk
 PF- 14

Project Finance risks

¾Completion risk
– Monetary aspect: Higher-than-anticipated
inflation, underestimation of construction costs
– Technical aspect: Higher-than-anticipated
expenditures required to make project
operational
¾Technological risk
– When the technology, on the scale proposed for
the project, will not perform according to
specifications or will become prematurely
obsolete
 PF- 15

Project Finance risks

¾Raw material supply
– In connection with natural resource
investments, the adequacy of reserves
¾Economic risk
– Inefficiency of operations, insufficient output
demand
¾Financial risk
– Rising interest rates, inability to service debt
reapayments
¾Currency risk
 PF- 16

Project Finance risks

¾Political risk
– The possibility that political authorities in the
host political jurisdiction may interfere with the
timely development and/or long-term economic
viability of the project
¾Environmental risk
– When the environmental effects of a project
may cause a delay in development or
necessitate a costly redesign
¾Force majeure risk
– Some discrete event might impair or prevent
altogether the operation of the project
 PF- 17

What is Project Finance?

Economic Issues

PF is mostly used in power, telecommunications, oil &

petrochemicals, infrastructure or real estate (monopoly rents and
tangible assets).

Size and risk considerations for firms or governments (economies of

scale and efficient allocation of risks). Public policy, employment,
economic growth and tax revenue considerations. Positive side
effects but also negative externalities.

Benefits and risks: During construction phase, large outlays and

technological and environment risks. During operation phase,
payoffs distributed to investors, exposed to market & political risks.
 PF- 18

What is Project Finance?

PF Statistics

Global Project Financed Investment

1994-2009 (In Billion Dollars)
450
400
350 High
300 leverage:
250
200
76% debt
150
100
50
0
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
Bank Loans Bonds Devel. Agencies Equity
 PF- 19

High Leverage: 76% Debt

Percentage Distribution of Debt-to-Total Capitalisation
(1,149 Projects)
2005 2006 2007 2008 2009 Total
<50% 8 8 2 0 5 4
50%-59% 9 7 8 8 10 8
60%-69% 12 15 16 16 22 16
70%-79% 29 20 25 25 27 25
80%-89% 26 22 27 26 21 25
>90% 16 28 22 25 15 22

Mean 74 75 77 78 72 76
Median 77 79 79 80 73 77
 PF- 20

Number and size of debt capital

Number of projects with Average size (in million $)
800 500

450
700
400
600
350
500
300

400 250
Bank Loans Bank Loans
Bonds 200 Bonds
300
150
200
100
100
50

0 0
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009

1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
 PF- 21

Distribution of Debt maturities

Bank Loans Bonds
2%

6% 3%
8% 15%
8%
26%
14%

19%

34%
26%
39%

< 5 yrs 5-9.9 yrs 10-14.9 yrs < 5 yrs 5-9.9 yrs 10-14.9 yrs
15-19.9 yrs 20-25 yrs > 25 yrs 15-19.9 yrs 20-25 yrs > 25 yrs
 PF- 22

What is Project Finance?

Project Finance Lending by Sector
1

3 2
4
5

9 39

14

24
Power Telecommunications
Infrastructure Oil & Gas
Petrochemicals Leisure & Property
Industrial Mining
Other
 PF- 23

Project Finance Lending by Region

4
4
6

33
Western Europe
7
Asia
Middle East
North America
12 Australia/New Zealand
Americas
Africa
Eastern Europe

16 18
 PF- 24

No. of equity sponsors

Percentage of all projects (923)
70%

60%

50%
Mean # of sponsors: 1.7
40%
Median # of sponsors: 1.0
30%

20%

10%

0%
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15
 PF- 25

What is Project Finance?

Size Distribution of Projects

60

50

40

30

20

10

0
Less than $50 - $100 $100 - $500 - $1 More than
$50 million million $500 billion $1 billion
million

Number (%) Value (%)

 PF- 26

Size Distribution by Sector

By the number of projects By the value of projects
Total Total

Agriculture Agriculture
Waste & Recycling Waste & Recycling
Telecommunications Telecommunications
Petrochemical Petrochemical
Water & Sewage Water & Sewage
Mining Mining
Industrial Industrial
Oil & Gas Oil & Gas
Transportation Transportation
Leisure & Property Leisure & Property
Power Power

0% 20% 40% 60% 80% 100% 0% 20% 40% 60% 80% 100%

Size of Project < $50 mil. Size of Project $50-$100 mil. Size of Project < $50 mil. Size of Project $50-$100 mil.
Size of Project $101-$500 mil. Size of Project $501 mil.-$1 bil. Size of Project $101-$500 mil. Size of Project $501 mil.-$1 bil.
Size of Project > $1 bil. Size of Project > $1 bil.
 PF- 27

Examples of Projects
Rion-Antirion Bridge www.gefyra.gr

The bridge was projected to cost about €800 million coming

from equity capital (10%), Greek state financial
contribution (45%), European Investment Bank (45%, loan
guaranteed by pool of banks).
 PF- 28

Examples of Projects
Agreement 1: Gefyra S.A. (the project) has signed a concession
contract with the State for the design, construction, financing,
maintenance and operation of the bridge.
Agreement 2: The design and construction contract for the
bridge was between Gefyra and Kinopraxia Gefyra (the
contractor).
Agreement 3: The checker contract between Gefyra and
Buckland & Taylor Ltd, an engineering consultancy.
Agreement 4: Under the supervision engineer contract between
Gefyra and FaberMaunsell Ltd., the engineering consultancy.
Agreement 5: The financial contribution agreement between the
State and Gefyra involves a subsidy from the State of €200
million.
 PF- 29

Examples of Projects
Agreement 6: The shareholders undertaking involve Gefyra,
Vinci, J&P, Elliniki Technodomiki, Volos Technical Company,
Athena, Proodeftiki and Sarantopoulos. The Gefyra
shareholders have committed to pay in €46.5 million as share
capital and to issue bank letters of credit.

Financial Agreements. Under the master facility agreement

between European Investment Bank (EIB) and Gefyra, a 25-
year, 370 million loan is granted to Gefyra.

Under the letter of credit facility agreement between Gefyra

and commercial banks, letters of credit guarantee payment to
EIB in the case of Gefyra default.
 PF- 30

Examples of Projects
Hibernia www.hibernia.ca

The Hibernia offshore oil

field is owned jointly by
ExxonMobil Canada
(33%), Chevron Canada
Resources (27%), Petro-
Canada (20%), Canada
Hibernia Holding
Corporation (8.5%),
Murphy Oil (6.5%) and
Norsk Hydro (5%). It
produces about 230
thousand BPD.
 PF- 31

Examples of Projects
Trans Alaska Pipeline System
(TAPS) www.alyeska-pipe.com

TAPS was constructed between 1974

and 1977. The 1,286 km oil pipeline
cost around $8 billion. Owners: BP
(47%), ConocoPhillips Transportation
(28%), Exxon Mobil (20%), Koch
Alaska Pipeline Co. (3%), and Unocal
(2%). Exxon Valdez, 1989.
 PF- 32

Examples of Projects
Iridium LLC www.iridium.com

The $5.5 billion project was backed by Motorola was planned to offer global
phone and data transmission services via 77 low-orbit satellites. The project
went bankrupt possibly because it had too much debt (60%) and
misestimated demand for its services.
 PF- 33

Examples of Projects
Yangtze River Three Gorges Dam, 长江三峡工开发, www.ctgpc.com

The largest hydroelectric power dam in the world. Fully operational in

2009, 18.2 MW capacity, producing enough energy to cover 3% of
China’s needs. Budget: About €20 billion, mainly from State and power
generation. Controversy. Relocation of 1.13 million people.
 PF- 34

Examples of Projects
Petrozuata www.pdvsa.com

Project to extract, transport

and refine Venezuelan heavy
oil, syncrude. Capacity: 160
thousand BPD. Ownership:
Conoco (50.1%), Maraven
(49.9%).
Budget: $2.43 billion (40%
equity, 60% debt).

Recent developments:
Sovereign risks.
Nationalization of assets,
review of contracts, charges
of tax evasion, etc.
President Chávez.
 PF- 35

Rationale for PF
¾Should the firm undertake the project as
part of its overall asset portfolio and finance
the project on its general credit or should
the firm form a separate legal entity to
undertake the project?
¾What amount of debt should the separate
legal entity incur?
¾How should the debt contract be structured?
 PF- 36

PF Advantages & Disadvantages

¾ Organization
Project can be organized as a partnership or limited liability
company.
The project has a finite life, and so does the legal entity that
owns it.
Project assets and cash flows are segregated from sponsors.
¾ Control and Monitoring
Management is subject to closer monitoring than in a typical
corporation.
Segregation of assets facilitates greater accountability to
investors.
Contracts contain provisions that facilitate monitoring.
 PF- 37

PF Advantages & Disadvantages

¾ Allocation of Risk
Creditors have limited or no recourse to the project sponsors.
Risks are allocated among parties best able to bear them.
¾ Free Cash Flow
Managers have limited discretion.
Free cash flow must be distributed to equity investors.
¾ Agency Costs
Agency costs are reduced.
Management incentives are easier tied to performance.
Closer monitoring by investors.
Underinvestment problem is reduced.
Financial flexibility is preserved.
 PF- 38

PF Advantages & Disadvantages

¾ Structure of Debt Contracts
Creditors look to specific assets for their debt service.
Debt contracts are tailored to project characteristics.
¾ Debt Capacity
Individual projects can obtain higher leverage than usual.
Sponsor firms are able to expand their debt capacity.
¾ Bankruptcy
Resolving financial distress is less costly.
Project is insulated from sponsor’s possible bankruptcy.
Lenders have limited chances to recover payment in
comparison to lending to corporations.
¾ Transaction and Other Costs
Higher transaction, contracting and information costs.
Financing arrangements are time-consuming.
Costs can exceed benefits!
 PF- 39

Structure
 PF- 40

Typical contractual arrangements

¾ The purpose of contractual security arrangements is to
apportion the risks among the project sponsors, the output
purchasers and other parties involved.
¾ These contractual arrangements serve as a means by which
the requisite credit support is conveyed to the project.
¾ These are categorised into
– Direct security interest in project facilities
– Security arrangements covering completion
– Security arrangements covering debt service (purchase & sale contracts)
• Take-if-Offered contracts: Obligates the purchaser of the project’s output or
services to accept delivery and pay for the output and services that the project
is able to deliver.
• Take-or-Pay contracts: Obligates the purchaser of the project’s output or
services to pay for the output and services whether or not the purchaser takes
delivery.
 PF- 41

Typical contractual arrangements

• Hell-or-High-Water contract: There are no “outs”, even in adverse circumstances
beyond the control of the purchaser; the purchaser must pay in all events, even if
no output is delivered
• Throughput agreement: Typically employed in connection with an oil or petroleum
product pipeline financing; during a specified period of time the operators ship
through the pipeline enough product to provide the pipeline with sufficient cash
revenues to pay all of its operating expenses and meet all of its debt service
obligations; typically supplemented with a cash deficiency agreement (“keep well”
agreement)
• Cost-of-Service contract: The contract requires each obligor to pay its
proportionate share of project costs as actually incurred, in return for a contracted
share of the project’s output
• Tolling arrangements: The project company levies tolling charges for processing a
raw material that is usually owned and delivered by the project sponsors
 PF- 42

Typical contractual arrangements

– Raw material supply agreements
– Supplemental credit support
• Financial support agreement: Can take the form of a letter of credit or similar
guarantee.
• Cash deficiency agreement: Designed to cover any cash shortfalls that would
impair the project company’s ability to meet its debt service requirements .
• Capital subscription agreement: Obligates one or more creditworthy parties
to purchase, for cash, securities issued by the project entity, to the extent
required to enable the project entity to cover any cash shortfall.
• Clawback agreement: Represents an undertaking to contribute cash to the
project to the extent the project sponsors (1) received any cash dividends
from the project company or (2) realised any project-related tax benefits on
account of their investments in the project.
• Escrow fund: Lenders may require the project to establish an escrow fund
that typically contains between 12 and 18 months’ debt service.
 PF- 43

Infrastructure Public-Private Partnerships

¾ Joint partnerships between public and private sectors for the

construction, financing, operation and ownership of projects
such as toll-bridges.
¾ Private firms aim at high returns.
¾ States benefit from a) fast and economically effective
construction and management of the project, b) tax collection
and c) indirect side effects.
¾ Political benefits within the political cycle.
¾ Private Finance Initiative (PFI) was established in the UK in
1992.
¾ Examples of PFI: A rail link to Heathrow airport (£320
million), Channel Tunnel Rail Link (£2.7 billion), and
hundreds of smaller projects involving roads, prisons,
hospitals and subways.
 PF- 44

Infrastructure Public-Private Partnerships

PPP Models
Perpetual Franchise Model: Private entities finance and operate the
project under a perpetual franchise from the host government. These
entities retain title to the assets. All the financial support for project-
related borrowings is provided by private entities.
Build-Operate-Transfer (BOT) Model: Private entities receive a
franchise to finance, build and operate the project for a fixed period of
time, after which ownership would revert to the host government. In
return for the ownership reversion, the host government might be asked
to furnish some (limited) credit support for project borrowings.
Build-Transfer-Operate (BTO) Model: Private entities design, finance
and build the project. They transfer legal title to the host government
immediately after the project facility passes its completion tests. The
private entities then lease the project facility back from the public
authorities for a fixed term. Under this model the host government has,
at most, a very limited responsibility for the project’s financial
obligations.
 PF- 45

Infrastructure Public-Private Partnerships

Buy-Build-Operate (BBO) Model: A private firm buys an existing facility

from the host government, modernises or expands it, and operates it as a
regulated, profit-making public use facility.
Lease-Develop-Operate (LDO) Model: A private firm leases an existing
publicly owned facility and surrounding land from the host government. It
then expands, develops, and operates the facility under a revenue-sharing
contract with the host government for a fixed term. The host government
holds legal title.
Wraparound Addition: A private firm expands an existing government-
owned core facility. The private firm holds legal title to the addition only,
thus ownership is shared.
Temporary Privatization: A private firm takes over operation and
maintenance of an existing government-owned facility. It then expands or
repairs the facility, operates it, and collects user charges long enough to
recover the cost of the expansion/repair.
 PF- 46

Infrastructure Public-Private Partnerships

Speculative Development: A private firm identifies an unmet public need.

Then, with the consent of the host government, it embarks on the process
of planning and obtaining permits at its own expense and risk. After the
private firm demonstrates the project’s financial feasibility and develops a
workable design, the host government joins in the development process,
perhaps by contributing to the financing of the project.
Value Capture: Seeks to convert a portion of the private benefits of
increased commercial activity to public use.
Use-Reimbursement Model: This model is distinguished by having the
host government enter into a utilisation contract with the project company.
 PF- 47

Internet Link & References

www.people.hbs.edu/besty/projfinportal

Esty, B. C., 2004, Modern Project Finance: A

Casebook, John Wiley & Sons, New York

Finnerty, J. D., 1996, Project Financing: Asset-Based

Financial Engineering, John Wiley & Sons, New
York