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PROJECT FINANCING

CONTENTS
INTRODUCTION AND HISTORY OBJECTIVES CHARACTERSTICS OF PROJECTS STRUCTURE RISKS INVOLVED BASIC SCHEME A FEW REAL WORLD CASES

INTRODUCTION
Project financing is an innovative and timely financing technique that has been used on many high-profile corporate projects. It is the long term financing of infrastructure and industrial projects based upon the projected cash flows of the project rather than the balance sheets of the project sponsors. The loans are most commonly non-recourse loans, which are secured by the project assets and paid entirely from project cash flow.

Financier principally looks to the assets and revenue of the project in order to secure and service the loan. In this situation, the credit risk associated with the borrower is not as important as in an ordinary loan transaction. The most important thing is the identification, analysis, allocation and management of every risk associated with the project.

HISTORY AT A GLANCE
Limited recourse lending was used to finance maritime voyages in ancient Greece and Rome Its use in infrastructure projects dates to the development of the Panama Canal. Project finance for high-risk infrastructure schemes originated with the development of the North Sea oil fields in the 70s and 80s. For such investments, newly created Special Purpose Corporations (SPCs) were created for each project.

Project financing in the developing world peaked around the time of the Asian Financial Crisis. Project finance structures emerged primarily in response to the opportunity presented by long term power purchase contracts available from utilities and government entities. In recent years, project finance schemes have become increasingly common in the Middle East, some incorporating Islamic Finance

WHY PROJECT FINANCING ?

Project Owners Perspective


Size and cost of projects Risk minimization Preservation of borrowing capacity and credit rating May be only way that enough funds can be raised

OBJECTIVES
Providing funds to a project is an important objective in itself. Monitoring by financial markets and institutions brings competition in service delivery. To provide another mechanism for investors to impose discipline. Avoid any negative impact of the project on the credit standing of the sponsors.

CHARACTERSTICS OF PROJECTS
Single purpose capital investment Stand alone entity Finite and long life Large in size

BASIC ELEMENTS OF A PROJECT FINANCING


Lenders Loan funds Debt repayment

Raw materials

Purchase contract(s)

Assets comprising the project Output Equity funds Returns to investors Cash deficiency agreement and other forms of credit support

Equity investors

STRUCTURE
Organizational Structure: Project companies involve separate legal incorporation. SPEs created to facilitate asset securitization share this feature of separate incorporation. Capital Structure: Project companies employ very high leverage compared to public corporations. The avj project company has a book value debt-to-total capitalization ratio of 70% compared to 30% for similar sized companies listed in the compustat database.

Ownership Structure: Project companies have highly concentrated debt and equity ownership structure. Most of the debt comes in the form of syndicated bank loans, not bonds, and is nonrecourse to the sponsoring firms. Contractual Structure: Project finance is sometimes referred to as contract finance. The four major project contracts govern the supply of inputs, purchase of outputs , construction, and operations.

RISK INVOLVED
The key to project financing is the reallocation of any risk away from the lenders to the project.

MINIMISING RISK
Step 1: Identification and Analysis. Step 2: Risk Allocation. Step 3: Risk Management.

TYPES OF RISKS AND WAYS TO REDUCE THEM


Participant Risks
-Sponsor commitment to project - Reduce Magnitude of investment?
-Require Lower Debt/Equity ratio

equity
Financially weak sponsor

-Finance investment through then by debt


- Attain Third party credit support for weak sponsor (e.g.,Letter of Credit)

sponsors Construction/Design defects

- Cross default to other


- Experienced Contractor - Turn key construction contract

Process failure warranties Completion Risks Cost overruns funding

- Process / Equipment - Pre-Agreed overrun

- Fixed (real) Price Contract Project not completed - Completion Guarantee Production/Operating Risks Operating difficulty leads to - Proven technology insufficient cash flow - Experienced Operator/ Management Team - Performance warranties on equipments - Insurance to guarantee minimum cash

Political Risk Covers range of issues from - Host govt. political risk assurances nationalization/expropriation, - Assumption of debt changes in tax and other laws, - Official insurance: OPIC, COFACE, EXIM currency inconvertibility, etc. - Private insurance: AIG, LLOYDS - Offshore Escrow Accounts - Multilateral Bilateral Involvement Abandonment Risk Sponsors walk away from project - Abandonment test in agreement for banks to run project closure based on historical and projected costs and revenues

BASIC SCHEME

Acme coal Co. exports coal /Energen Inc supplies energy. Both form an SPC (divide the shares in accordance with their contribution). SPC signs contract with a construction company. SPC gets financing from development and commercial banks to pay the construction company. Acme and Energen form another SPC to manage the facility.

If any disaster happens ,plaintiffs cannot sue Acme or Energen because neither of them own or operate the plant. An SPA then allows trading between SPC and Acme and electricity is delivered to Energen using wholesale delivery contract. The cash flow from these transaction will be used to pay the financers.

A FEW REAL WORLD CASES


Panama Canal construction. Gamsberg Zinc mining project in South Africa (The largest Zinc mine in the world was financed at US $900 million) Australia Japan Cable. (12,500km cable from Sydney, Australia to Japan via Guam at a cost of $520m. Key sponsors: Japan Telecom, Telstra and Teleglobe. Asset life of 15 years.) Iridium LLC. (A $5.5bn satellite communications project backed by Motorola which went bankrupt in 1999 after just one year of operations. Had partners in over 100 countries.)

TOP BANKS IN PROJECT FINANCING :1. SBI Capital 2. Calyon 3. BNP Paribas 4. Societe Generale 5. IDBI Bank *India topped Project Finance deals in 2010 with $30 billion (21.5% of Global Project Finance).

BIBLIOGRAPHY
www.google.com www.eagletraders.com en.wikipedia.org www.pwc.com

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