"description": "Solution. A simplified project structure example:A nexus of contracts that aids the sharing of risks, returns, and control Source: Esty, B., An Overview of Project Finance 2002 Update: Typical project structure for an independent power producer Hedging contracts.
), A contract defining the turnkey responsibility to deliver a complete project ready for operation (a.k.a. The credit rating may proxy for many of these fundamental risks as it is survey based. "@type": "ImageObject", }, 17 "description": "Historically formed to finance large-scale projects. Bank debt with a small banking group was preferred rather than project bonds to have flexibility. "@type": "ImageObject", Alumina accounted for 33% of production costs. Strong debt covenants allow both sponsors and creditors to better monitor management. Pre-completion risks and mitigationResource Risk: Quantity and quality of the crude oil Petrozuata being a development and not an exploration project: An independent evaluation found that the field contain 21.5 barrels of oil. Project financed investment exposes the sponsor to losses only to the extent of its equity commitment, thereby reducing its distress costs.
Project finance allowed raising a large amount of debt on a non-recourse basis, which was impossible at the parent level, The structure gave Calpine flexibility to build the plants using equity, and manage them flexibly as part of a power system (which would be impossible with separately project financing the individual plants). "width": "800" ", power, roads), technology transfer, creating permanent employment opportunities (873 jobs) and 5000 construction jobs as well as human capacity building Diligent environmental and social impact analysis by IFC Social programs planned for Mozambican people Govt established a special committee to ease the bureaucratic / administrative hurdles for the Mozal project Govt signed an Investment Protection Agreement with South African Govt for cross-border projects Government committed to economic and legal reforms In addition to the positive externalities outlined above, Govt might have also been given an equity share to better ensure it has a vested interest in the projects success to minimize risk of expropriation (See Chad-Cameroon Case) Costs: Harder, costlier, and more time consuming to set up. "@context": "http://schema.org", "@context": "http://schema.org", "contentUrl": "https://slideplayer.com/slide/5357710/17/images/70/Chad-Cameroon+Petroleum+Development+and+Pipeline+Project.jpg", Internal: Incentive problems during construction and operation stages. "contentUrl": "https://slideplayer.com/slide/5357710/17/images/99/Sovereign+risks+and+mitigation.jpg", "contentUrl": "https://slideplayer.com/slide/5357710/17/images/67/The+Country+Risk+Rating+Model.jpg", "@context": "http://schema.org", With less than perfect correlation among its assets, ExxonMobil might actually have been able to eliminate the idiosyncratic risks via adding a field development project to its portfolio. "@context": "http://schema.org", The ability to handle such risks are important to prevent likely cost overruns or construction delays Conoco had sufficient project experience and technological knowhow with its proven production and refining technology Maraven also had significant production technology and experience The pipelines would run 125 miles between the oil fields and the coast, increasing risk exposure The terrain between the oil fields and the coast was relatively flat and sparsely populated, which would ease pipeline construction Most of the pipelines would be laid underground The well drilling technology to be used had been an established one, used in both the Oronoco belt and all around the world EPC contracts for the downstream facilities and pipelines were planned to put out to bid to a consortia of leading international contractors Contracts for upstream constructions were planned for experienced and authorized Venezuelan companies Corporate financing as opposed to project financing helped ExxonMobil keep the project as part of its portfolio and reduce the risks. ", "contentUrl": "https://slideplayer.com/slide/5357710/17/images/71/Background.jpg", ", { "width": "800" "@type": "ImageObject", Structural Solutions: Since project is large scale and the company is stand alone, acts of expropriation are highly visible in the international arena which detracts future investors. Gov\u2019t claimed to have little intention of allowing the plan to affect local practice Criticism on oversight committee\u2019s composition and power.
"name": "Pre-completion risks and mitigation", Profit sharing mechanisms or tax incentives may change how variability in income is shared among sponsors, lenders, government, and labor. ", ", Value creation by contractual structure: An Introduction to Risk ManagementMechanisms to reduce cost of risk: Capital, financial, and futures markets: Mix of debt and equity (capital structure) and probability of default Risk spreading / pooling Risk diversification Insurance markets (for residual risks) Derivative financial instruments (not available for asymmetric risks) Futures markets Real options: Design flexibility into project to allow for responses of new information or market changes Project design itself for risk mitigation (elements of production process, technology used, etc.) Usage of Monte Carlo simulation. The sponsors are Alusaf, a subsidiary of a South African natural resource company, and IDC, a government-owned South African development bank with long-standing relationship with Alusaf. "name": "Risk Management Identification and mitigation of:",
"description": "Technological risk: How proven is the technology used How experienced are the contractors to handle technological risks The ability to handle such risks are important to prevent likely cost overruns or construction delays. "description": "Who bears risk Sponsors bear the residual gains and losses, and make key investment decisions. }, 54 "contentUrl": "https://slideplayer.com/slide/5357710/17/images/109/Risk+Management+Identification+and+mitigation+of%3A.jpg", Attain third party credit support for weak sponsor (letter of credit), Market risk: Uncertainty regarding the future price and demand for the output. "@type": "ImageObject", Case analyses.
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. ", "name": "Value creation by organizational structure: Debt Overhang", Government\u2019s equity ownership. "description": "*C. Harvey\u2019s International Cost of Capital Calculator. This way counterparty incentives are aligned. "width": "800" { Organizational Structure. ", "width": "800" "name": "Major project contracts:", 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. ",
Benefits of debt-based governance. Structural decisions may affect the existence and magnitude of costs due to market perfections: * Asymmetric information between parties involved, Concentrated equity ownership and single cash flow stream provides critical monitoring, Strong debt covenants allow both sponsors and creditors to better monitor management, High debt service reduces the free cash flow exposed to discretion, Extensive contracting reduces managerial discretion, Cash Flow Waterfall mechanism facilitates the management and allocation of cash flows, reducing managerial discretion. When firm value decreases due to cost of financial distress which increases with combined variance. Value creation by contractual structure: Contracting and Project Finance to reduce cost of riskContracting criteria: Contract with lowest cost not necessarily best contract Effective contracts may provide: Better risk shifting: better distributions of cost Better incentives: higher project returns or lower total project risk as a result of incentives Change the incentive structure to change the probabilities of different outcomes stakeholders have incentives to increase probability of success and reduce probability of failure in project Zero Sum (Competitive) versus Positive Sum (Integrative) perspectives Cost focus is implicitly a zero sum perspective: one stakeholder gains and the other stakeholder loses Integrative focus is explicitly a positive sum perspective: By crafting the right contract, one stakeholder can gain without necessarily costing to the other one (due to differences between perceived values, preferences, and risk bearing capacity) contracts that create increased value through risk sharing and /or improved incentives }, 55 Hyperinflation risk: Relative changes in the price of inputs and output may adversely affect the project. WB responded by requiring that the proceeds should be repaid out of general revenues, suspended new loan programs, and also set up a new oversight body headed by external people. Force Majeure risk: Likelihood of occurrence of political events like wars, labor strikes, terrorism, or nonpolitical events such as earthquakes, etc. Construction cost overruns: reduce equity returns, and DSCR. 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", The role of IFC Providing long-term capitalWilling to lend senior debt and subordinated debt, and also equity Longer maturities compared to bank loans: 7-12 years on senior debt and 8-15 years on quasi-equity Compared to commercial banks, willingness to bear higher risks for the same return because of the developmental aims it attaches to projects It provides a catalytic effect on other lenders once it agrees to participate in a project Empirical evidence suggests IFC involvement increases the country credit ratings, encouraging future investment in high-risk countries Deterring sovereign interference IFC pays attention to structure fair deals that would benefit the governments and then monitor them to preclude short-term opportunistic behavior Halo effect: IFC, with virtue of being a WB affiliate, receives preferential treatment from the governments in terms of debt obligations, and hence provides indirect protection for the lenders Project update.
"description": "The lead sponsor, ExxonMobil had AAA debt rating, very strong balance sheet ($145M assets) and $16M cash flow \uf0e0 Could afford the field investment in a less costly way relative to project financing.
High leverage reduces free cash flow exposed to discretion. Agency costs, debt overhang, risk contamination, risk mitigation. "width": "800" "contentUrl": "https://slideplayer.com/slide/5357710/17/images/103/Real+Options+%E2%80%93+value+of+flexibility.jpg", "@context": "http://schema.org", Separate incorporation eliminates potential increase in risk when financing a project strongly correlated to sponsors existing asset portfolio. Gov\u2019t wouldn t want to curb the investments, because they are interested in development. "width": "800" Case examples to value creation. "contentUrl": "https://slideplayer.com/slide/5357710/17/images/91/Risk+management+Identification+and+mitigation+of%3A.jpg", "width": "800" Why use Project Finance?Positive-sum as opposed to a zero-sum deal for PDVSA and Venezuela: Cost focus would be a zero sum perspective for both PDVSA and Conoco (one party gains and the other loses) Involvement of experienced Conoco and Du Pont in the deal may help increase the aggregate net cash flows to the project, due to efficiency gains as well as risk sharing/allocation benefits (positive-sum perspective) Massive tax benefits Under project finance, the project is subject to significantly lower income tax rates (34% as opposed to 67.7%) and royalties. }, 128 Financing the projects as one package may be examined as a potential solution, as long as the sponsors\u2019 interests on both sides can be aligned. 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. "contentUrl": "https://slideplayer.com/slide/5357710/17/images/85/Project+Update.jpg", "@type": "ImageObject", "width": "800" }, 78 { 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 project\u2019s permits, changing the control of company. Investment specific equity from foreign investors is either hard to get or expensive.
Infrastructure projects: toll roads, power plants, telecommunications systems. Success in this project will be a proof of concept for the rest. "@type": "ImageObject",
As economic situation worsened, Gov\u2019t demanded and received extraordinarily high dividends from PDVSA reaching up to 134% of projected income in Hugo Chavez won the 1998 elections and announced not to interfere with foreign oil investments. ", Petrozuata being a low cost producer with breakeven price well below industry average could still operate even if prices fell dramatically. "name": "Pre-completion risks and mitigation", Implications of a sudden major local currency devaluation in cases where the project revenue is in local currency and debt in foreign currency. "width": "800" }, 41 Risk spreading \/ pooling. Capacity agreements with high rated sponsors would also be instrumental in raising debt with favorable conditions. "name": "Why use Project Finance", "@context": "http://schema.org", Insurance for natural disasters Project finance is preferred when cost of risk contamination exceeds the benefits of co-insurance. If cash flows are in local currency, convert into $US: Calculate the difference between the multiyear forecasts of inflation in the host country and those in US Use the difference to map out the expected exchange rates Use calculated expected exchange rates to convert cash flows into $ Adjust for industry risk: Calculate the country risk premium from ICCRC: Country risk premium = Country cost of equity capital US cost of equity capital Calculate US industry cost of capital by using industry beta Add the country risk premium to US industry cost of capital Adjust for project specific risks that deviate the project from the average level of risk in the host country Risks incorporated in cash flows or industry adjustment: Pre-completion: technology, resource, completion. "contentUrl": "https://slideplayer.com/slide/5357710/17/images/77/Subjects+of+opposition%3A.jpg", 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 "width": "800" Social programs planned for Mozambican people. }, 9 { 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 "@context": "http://schema.org", Value creation by contractual structure: Sovereign risks:Solution Political risks: Likelihood of occurrence of political events like wars, labor strikes, terrorism, etc. Value creation by contractual structure: An Introduction to Risk ManagementThe process of identification, assessment, mitigation, and allocation of risks to reduce cost of risk and improve incentives Sources of risk: External: Markets: Availability and quality of products, inputs, and services used Financial markets Government policy Natural resource availability and quality Natural disasters, politics Internal: Incentive problems during construction and operation stages Relationships between management, sponsors, lenders, workers, suppliers, government (some addressed in the previous slides under value creation by organizational structure) 
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