Ensures that the operating and maintenance costs stay within budget, and project operates as planned. Risk management. ", Project finance allows better allocation or sharing of risks via contractual relationships, thereby reducing the cost of risk. "@context": "http://schema.org", imbedded flexibility to respond to changing conditions (real options) changing tax rates. FINANCE IN A CANADIAN SETTING Sixth Canadian Edition Lusztig, Cleary, Schwab. High leverage and dedicated cash flows via the cash waterfall structure helps prevent opportunities for risk shifting, underinvestment, or cross-subsidization of negative NPV projects. But losing the benefit of co-insurance which would come with corporate financing, High leverage and dedicated cash flows via the cash waterfall structure helps prevent opportunities for risk shifting, underinvestment, or cross-subsidization of negative NPV projects, From lenders perspective, separated cash flows also allow easier monitoring and possibly lower monitoring costs, Project finance allows better allocation or sharing of risks via contractual relationships, thereby reducing the cost of risk, 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, Resource Risk: Quantity and quality of the crude oil. Better qualified to do sovereign risk analysis given its development experience and relationships with governments. Instrumental in harmonizing the legal structures of Mozambique and South Africa to create an agreed-upon basis for dispute resolutions. Post-completion risks: Market risk, supply risk, operating cost risk, and force majeure. Costs: The high-yield market was thinner and more volatile compared to investment grade market, creating pricing and availability risk. Case examples to value creationIssues: 4. Long term off-take contract with creditworthy buyers: take and pay, take or pay, take if delivered contracts: An undertaking to pay a long-run average price, Specific price escalator clauses that would maintain the competitiveness of the product, such as indexing price to the price of a close substitute or cost of major input, Operating cost risk: Uncertainty regarding the changes in the operating cost throughout the life of the project. }, 86 Drawbacks of Using Project Finance Structure:Takes longer to structure and execute than equivalent size corporate finance Higher transaction costs due to creation of an independent entity and complex contractual structure Non-recourse project debt is more expensive due to greater risk and high leverage High leverage and extensive contracting restricts managerial flexibility Project finance requires greater disclosure of proprietary information to lenders Still, the combination of organizational, financial, and contractual features may offer an opportunity to reduce net cost of financing and improve performance Structure matters, contrary to MM Proposition! "description": "Takes longer to structure and execute than equivalent size corporate finance. A fixed price growth path. "contentUrl": "https://slideplayer.com/slide/5357710/17/images/33/Value+creation+by+contractual+structure%3A+Pre-completion+risks%3A.jpg",
Project Finance: Pre-completion risks: Resource, technological, timing, and completion risks. ", Guarantees of obligations by the contractor s parent company. Permits: Contracts that ensure permits and other rights for construction and operation of the project, as well as for investing in and financing of the Project Company May be provided by central governments and/or local authorities Government Support Agreements: Provisions may include guarantees on usage of public utilities, compensation for expropriation, tax exemptions, and litigation of disputes in an agreed jurisdiction Avoidance of possible risk contamination But losing the benefit of co-insurance which would come with corporate financing Value creation by organizational structure: Other motivationsProblems Structural Solutions: Joint venture projects with heterogeneous partners: Financially weaker partner cannot finance its share of investment through corporate borrowings, and needs project finance to participate Location: Large projects in emerging markets usually cannot be financed by local equity due to supply constraints. The project with potentially high returns and developmental impact for Chad was also aligned with WB\u2019s policy objectives. "description": "Temporary stop option if oil price drops. Contractual Structure. 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. "@context": "http://schema.org", }, 26 Corporate finance vs. project finance. Risks manageable via contractual structure or other mechanisms in. "width": "800" "description": "How project structure may help: Using project finance as the financing method: Benefits: Reducing project\u2019s potential negative impact on the balance sheet: The project was very large and posed too many risks which BP Amoco could not bear alone, meaning a potentially huge negative impact on the balance sheet if financed solely by internal funding. Risk-return trade-offs may enable integrative (not necessarily competitive) negotiations among different stakeholders and may create value in a project setting. }, 47 "@context": "http://schema.org", }, 90 E.g. "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. IFC pays attention to structure fair deals that would benefit the governments and then monitor them to preclude short-term opportunistic behavior. OUTLINE What is Project Finance?How does project finance create value? "contentUrl": "https://slideplayer.com/slide/5357710/17/images/85/Project+Update.jpg", "description": "Using high leverage: Ensures cash flows are kept low so that temptation for seizure is low. Case examples to value creation. Project finance is preferred when cost of risk contamination exceeds the benefits of co-insurance. 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 "width": "800" "@context": "http://schema.org",
"width": "800" "description": "Problems. Significant financial, developmental, and social returns. ", "@type": "ImageObject", "@context": "http://schema.org", { 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
"name": "Real Options \u2013 value of flexibility", 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. Explains developed and emerging markets. ", $4bn Chad-Cameroon pipeline project. How they funded the initial phase would change possibilities of financing for the coming stages. "contentUrl": "https://slideplayer.com/slide/5357710/17/images/27/Value+creation+by+contractual+structure%3A+An+Introduction+to+Risk+Management.jpg", ", Sovereign risks (Major risk group in this project and the reason for project financing) Financial risks. IFCs concerns are the size of the project, as well as the political risks of doing business in Mozambique. "width": "800" The growth strategy includes building and operating a power system consisting of multiple power plants. "@context": "http://schema.org", In addition to the positive externalities outlined above, Gov\u2019t might have also been given an equity share to better ensure it has a vested interest in the project\u2019s success to minimize risk of expropriation (See Chad-Cameroon Case)", "name": "OUTLINE What is Project Finance", Approaches to calculating the Cost of Capital in Emerging MarketsMany of these methods suffer problems because: Method does not incorporate all risks in the project Assume that the only risk is variance, and fails to capture asymmetric downside risks Assume markets are integrated and efficient Arbitrary adjustments which either over or underestimate risk Confusing bond and equity risk premia. Introduction to Derivatives and Risk Management Corporate Finance Dr. A. DeMaskey. The Beta with the World portfolio is not indicative of the sovereign risk of the country (asymmetric downside risks). "description": "Resolving possible agency conflicts.
"contentUrl": "https://slideplayer.com/slide/5357710/17/images/84/Project+Update+After+WB+approved+the+deal%2C+President+Deby+used+part+of+the+proceeds+to+buy+weapons..jpg", "name": "Sovereign risks and mitigation",
"@type": "ImageObject", { CHAPTER 18 Derivatives and Risk Management. 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 creation. Case examples to value creationAustralia-Japan Cable Structuring a Project Company: Background: The project included a 12,500 km submarine telecommunications system between Australia and Japan via Guam at a cost of $ 520M. }, 87 Benefit from portfolio diversification is negative (risk is higher) when sponsor and project cash flows are strongly positively correlated. Joint ownership with related parties to share asset control and cash flow rights. { 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) ", Benefits of debt-based governance. Necessity to be a low-cost producer in a commodity market. { Venezuelas historic political and economic instability, Oil facilities are generally targets of terrorism due to their significance in economy, Projects agreements were defined to be invalid in case of force majeure events, The pipelines will be constructed underground, and in a sparsely populated area, Leverage 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, Option to sell the excess capacity to future projects in the area, Option to abandon the project, since the project consists of several stages, *C. Harveys International Cost of Capital Calculator, 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, Sovereign risks (Major risk group in this project and the reason for project financing). Export system was the riskiest part of the project.
"@type": "ImageObject", "description": "How does project finance create value Project Valuation. 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. (Corporate Finance), Economically and legally independent project company, Founded extensively on a series of legal contracts that unite parties from input suppliers to output purchaser, Project assets/liabilities, cash flows, and contracts are separated from those of the sponsors, conditional on what accounting rules permit, Investors and creditors have a clear claim on project assets and cash flows, independent from sponsors financial condition, Debt is either limited (via completion guarantees) or non-recourse to the sponsors, 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, Sponsors provide capital in the form of equity or quasi-equity (subordinated debt), Governing Board comprises of mainly affiliated directors from sponsors, Historically formed to finance large-scale projects, Industrial projects: mines, pipelines, oil fields, Infrastructure projects: toll roads, power plants, telecommunications systems, Significant financial, developmental, and social returns, $135bn of capital expenditure globally using project finance, Smaller than the $612bn corporate bonds market, $397bn asset backed securities market and $205bn leasing market; approximately same size with the $27bn IPO and $26bn venture capital market, 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, A framework under which Project Company obtains revenues, Provides the offtaker (purchaser) with a secure supply of project output, and the Project Company with the ability to sell the output on a pre-agreed basis.
