Pakistan has a beta of 0. With a total proven plus probable reserves of 917M barrels, downside exposure to price and resource risk was already mostly eliminated No serious need to protect from the downside risk (via risk sharing )with project finance and incurring higher interest rates and loan fees. Both Conoco and Maraven had significant project experience to handle the execution complexities. Possible negative influence of Gov\u2019t on the effective functioning of offshore proceeds account. "width": "800" Financial risks and mitigationLeverage risk: Balancing the incentive to maximize the equity returns (via leverage) against the likelihood of default and failure to get an investment grade rating The target leverage of 60% turns out to be just right to allow for a minimum DSCR of about 2.08X (in year 2008), which exceeds the minimum acceptable ratio of 1.80X allowed for an investment grade rating More equity commitment actually signals that sponsors perceive the project as right The expectation was that the Chad and Cameroon Govts would be less likely to take or tolerate adverse actions against the project in fear of jeopardizing future funding from the WB and other international financing institutions who were lenders of last resort Additionally, it facilitated alignment of Govts interests with the project through equity ownership, which would not have been possible otherwise as Govts could not afford on their own Project financing also created the opportunity for the pipeline companies (JV between Govts and the sponsors) to issue limited-recourse debt, guaranteed by the sponsors through completion Project financing enabled external monitoring from the lenders ExxonMobil also reduced total investment commitment to the project under the corporate/project finance structure, compared to that under a complete corporate finance structure 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. "contentUrl": "https://slideplayer.com/slide/5357710/17/images/40/Value+creation+by+contractual+structure%3A+Sovereign+risks%3A.jpg", ", Gives the cost of capital of an average project in the country in $). Conversely, a likely depreciation of the Bolivar would increase the revenues (in $) against the local operating expenses (in Bolivar) in relative terms. High leverage reduces expropriation risk. "contentUrl": "https://slideplayer.com/slide/5357710/17/images/20/Value+creation+by+organizational+structure%3A+Agency+Costs.jpg", Corporate financing for the field system: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 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. Japanese Government seemed not likely to approve building of a new landing station. { "contentUrl": "https://slideplayer.com/slide/5357710/17/images/13/How+Does+It+Create+Value.jpg", Case analyses. "width": "800" The lead sponsor, Telstra, has to structure the project company, selecting an ownership, financial, and governance structure. "@type": "ImageObject", Value creation by contractual structure:An introduction to risk management Risk management defined Sources of risks Who bears risk? { Cost of capital calculation**C. Harveys International Cost of Capital Calculator }, 30 More appropriate approaches to project valuation may include: Usage of non CAPM based discount rates especially for emerging markets investments, Changing discount rate to account for changing leverage, Incorporate idiosyncratic risks in cash flows and account for systematic risks in discount rate, World CAPM or Multifactor Model (Sharpe-Ross), Goldman-integrated sovereign yield spread model. Adjust for project specific risks that deviate the project from the average level of risk in the host country. "@type": "ImageObject", CSFB volatility ratio model. Careful review of the project scale in relation to the size of contractor\u2019s overall business. ", "contentUrl": "https://slideplayer.com/slide/5357710/17/images/68/OUTLINE+What+is+Project+Finance.jpg", The content of this presentation has been derived from: Emerging Markets Corporate Finance Course materials taught by Campbell Harvey at Duke University, Project Finance lecture slides by Campbell Harvey, Aditya Agarwal, Sandeep Kaul at Duke University, Modern Project Finance: A Casebook, Benjamin Esty, John Wiley & Sons, 2004, Principles of Project Finance, E.R. Profit sharing contract with labor. Costs: Project might create additional risks in BP Amoco\u2019s current asset portfolio \uf0e0 Risk contamination. "name": "Financing the Mozal Project", Government committed to economic and legal reforms. "description": "Petrozuata is a $2.4B integrated oil field development project in Venezuela. ", }, 79 "name": "Project Valuation Background", "description": "Many of these methods suffer problems because: Method does not incorporate all risks in the project. "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. "width": "800" Examples of project-financed investments. { }, 95 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. Case examples to value creationIssues: Speed was very important to gain first mover advantage Necessity to be a low-cost producer in a commodity market Operating a system of power plants to gain scale economies and also the flexibility to switch between the plants to offer uninterrupted service 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. { ", It provides a catalytic effect on other lenders once it agrees to participate in a project. "@type": "ImageObject", This way counterparty incentives are aligned. { "@type": "ImageObject", { High leverage also reduces accounting profits thereby reducing the potential of local opposition to the company. "contentUrl": "https://slideplayer.com/slide/5357710/17/images/71/Background.jpg", 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. BP Amoco\u2019s absence in the IFC\/EBRD finance deal for the MIG would make it harder for the weaker partners to negotiate good terms, reducing flexibility in operations and management. ", 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. }, 107 Relationships between management, sponsors, lenders, workers, suppliers, government. The priority and challenge for the sponsors is to craft the projects operational and financial details so as for the project to achieve an investment grade rating. Nonperformance on completion: due to poor design, inadequate technology. { "name": "Major characteristics:", ", "@type": "ImageObject", }, 92 Value creation by Project Finance. How experienced are the contractors to handle technological risks? Government policy. }, 2 Some risks can be reduced by spreading the burden across many participants; some other risks cannot be spread, but can be shifted or reallocated Different stakeholders in a project may have different preferences, and hence different willingness and capacity to bear risks Cost of risk is lower to those with greater capacity and willingness to bear risk Risk-return trade-offs may enable integrative (not necessarily competitive) negotiations among different stakeholders and may create value in a project setting Gains in economic efficiency can be achieved if overall cost of risk declines through risk shifting and reallocating: The same risk will have a lower cost if born by parties better capable and willing to do so Process failures. "@context": "http://schema.org", "description": "Problems. { "contentUrl": "https://slideplayer.com/slide/5357710/17/images/72/Corporate+financing+for+the+field+system%3A.jpg", 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 Chad\u2019s perspective, the timing of cash flows were not negotiated to the advantage of Chad. Extensive contracting reduces managerial discretion. "width": "800" Structuring the legal\/financial documents. Separate incorporation eliminates potential increase in risk when financing a project strongly correlated to sponsors existing asset portfolio. Hyperinflation risk: Relative changes in the price of inputs and output may adversely affect the project. }, 5 "name": "Sovereign risks Expropriation risks:", Close monitoring \/ testing of project execution (operational, financial, etc.) ", Value creation by Project Finance. 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. Each of the partners had a choice in how to finance its share of the total investment. $1.4bn aluminum smelter in Mozambique. Post-completion risks: Market risk, supply risk, operating cost risk, and force majeure. Force Majeure risk: Likelihood of occurrence of political events like wars, labor strikes, terrorism, or nonpolitical events such as earthquakes, etc. "contentUrl": "https://slideplayer.com/slide/5357710/17/images/44/Value+creation+by+governance+structure%3A.jpg", Ensures that the operating and maintenance costs stay within budget, and project operates as planned. They would be made to sign presale capacity agreements (\uf0e0 reducing variability). "@type": "ImageObject", Traditional CAPM method is inaccurate: Many mega projects are in emerging markets. The growth strategy includes building and operating a power system consisting of multiple power plants. { Project update. ", Agency costs, debt overhang, risk contamination, risk mitigation. ", "contentUrl": "https://slideplayer.com/slide/5357710/17/images/123/What+happened+IFC+approved+the+%24120M+investment+in+1997%2C+its+largest+investment+by+then..jpg", "@type": "ImageObject", Background ExxonMobil, Chevron, and Petronas undertake a $4 Billion petroleum development and pipeline project in Chad, which presented a unique opportunity to stimulate Chads economic development, and yet entailed environmental and social risks. "description": "Market risk: Uncertainty regarding the future price and demand for the output. { "contentUrl": "https://slideplayer.com/slide/5357710/17/images/48/Case+examples+to+value+creation.jpg", "width": "800" }, 97 "width": "800" Contractual structure in Project Finance to reduce cost of risk and create value. Value creation by contractual structure: Pre-completion risks:Solution Construction cost overruns: reduce equity returns, and DSCR Pre-agreed overrun funding (contingency finding) Fixed (real) price contract, as the EPC contract is normally the largest cost item in budget (60-70%) Contractor takes junior debt and/or equity stake in operations (BOT or BOO) Delay in completion: failure to meet the milestones increase costs, reduce equity returns, and reduce DSCR Financing costs, especially as debt will be outstanding longer Revenues from operating the project will be lost or deferred (significant risk also especially if part of financing depends on early revenues) Penalties may be payable under contract to input suppliers or off-taker Completion guarantees, date-certain EPC contract Performance bonds Completion bonuses/penalties Reputable contractor Close monitoring / testing of project execution (operational, financial, etc.) Benefits of debt-based governance. { "description": "INTRODUCTION TO PROJECT FINANCE", { "width": "800" "name": "Value creation by contractual structure: Financial risks:", Risk management: Protection of BP Amocos balance sheet from risk contamination or distress costs from investing in a risky asset Involvement of multilateral organizations: Increased capacity to raise capital Better incentives: higher project returns or lower total project risk as a result of incentives. 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. "@context": "http://schema.org", "@type": "ImageObject", "description": "Solution. Governance structure. Value Creation. However, in expectation of the development of such a market in the near future, Petrozueta retained the option to sell the syncrude to third parties if they demand at a higher price than Maya crude. ", 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 Social programs planned for Mozambican people. "description": "Drawbacks of using Project Finance. "@type": "ImageObject", Recap - Type of assets/projects and appropriate method of financing:Corporate Finance: When the asset is less than perfectly correlated to the rest of companys asset portfolio, corporate financing may help eliminate idiosyncratic risks via diversification 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 Corporate finance is preferred when it results in lower combined variance due to diversification (co-insurance). "name": "The role of IFC Providing long-term capital", "width": "800" }, 116 "@context": "http://schema.org", 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. After these reforms, WB and IMF permitted debt relief to Chad. "name": "Case examples to value creation", The project received ratings that exceeded the sovereign ratings by five notches 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, 1997 PDVSA continued to structure deals for the Orinoco Basin Venezuelan economy was hit hard by the decline in crude oil prices S&P revised its outlook for Petrozuata to negative, as a result of the cost overruns, lower than expected early production revenues, falling prices, and political uncertainty As economic situation worsened, Govt demanded and received extraordinarily high dividends from PDVSA reaching up to 134% of projected income in 1999 Hugo Chavez won the 1998 elections and announced not to interfere with foreign oil investments 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. "width": "800" Construction cost overruns: reduce equity returns, and DSCR.
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