Changing discount rate to account for changing leverage. "name": "Case examples to value creation", "@type": "ImageObject", }, 80 { "contentUrl": "https://slideplayer.com/slide/5357710/17/images/104/Cost+of+capital+calculation%2A.jpg", Japanese Government seemed not likely to approve building of a new landing station. The second tranche would also be repaid in 5 years, but from future sales, acting as trip wires for the management team. Sources of risk: External: Markets: Availability and quality of products, inputs, and services used. }, 47 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.) Changing of taxation \u2013 creeping \u2013 moderate risk: Gov\u2019t may remove the privileges that the smelter would be exempt from customs duties and income taxes. "name": "Value creation by governance structure:", The growth strategy includes building and operating a power system consisting of multiple power plants. Project was structured in the following way to ensure that an expropriation would have international consequences, and also lenders would be comfortable enough to participate in the project: Existence of international commercial partners: International suppliers: Power from Eskom of South Africa, alumina from an Australian supplier, technology from France, most of the other inputs (coke, petroleum, etc.) { ", The alternatives BP Amoco considered for its share were corporate financing, project financing, or a hybrid structure. Idiosyncratic risks are usually incorporated in the discount rate as a fudge factor. "@context": "http://schema.org", Case examples to value creationHow project structure may help: Contemplated on concentrated equity ownership to maintain more effective management and monitoring As for an interim management team, sponsors would also be made equal partners in control, regardless of individual ownership shares A permanent management team was discussed, that would work exclusively for the project: Management compensation package was easier to craft, since it was a single purpose company with limited and well-defined growth opportunities Single cash flow easier to monitor Why use Project Finance?Strategic reasons in the long run: $2.4B Petrozuata will be the first in a series of projects planned which total as high as $65 B. PDVSA needs to preserve debt capacity for future funding needs. Assuming production level of 120,000 BPCD and 35 years project life, 7% of these reserves is sufficient to sustain the project, Variability in the available crude oils quality was not deemed to be significant to reduce the efficiency of upgraders. Post-completion risks: Market risk, supply risk, operating cost risk, and force majeure. 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, 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. Government committed to economic and legal reforms. Corporate financing for the field system:Field development was the less risky part of the entire project for the sponsors, because upstream operations including field development and production was one of the core business areas where they were very strong at. Serious inflation levels that reached 100% in", Project Finance mechanism: complex contractual arrangements involving all mechanisms of contractual risk allocation and reduction to deal with risk in large scale investments Assume markets are integrated and efficient. Structuring the project contracts to allocate risk, return, and control. Corporate finance is preferred when it results in lower combined variance due to diversification (co-insurance). In simple terms, Return to equity = Revenues Material / service costs Labor costs Depreciation Interest expenses Taxes Variability in RHS variables lead to changes in return to equity 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 = Revenues Material / service costs Depreciation Profit sharing mechanisms or tax incentives may change how variability in income is shared among sponsors, lenders, government, and labor Output purchasers and input suppliers can also share the risks as they experience variability in their markets Multilateral lenders\u2019 involvement detracts governments from expropriation since these agencies are development lenders and lenders of last resort. "@type": "ImageObject", It is very difficult to estimate Beta with the World portfolio. }, 22 "@type": "ImageObject", "contentUrl": "https://slideplayer.com/slide/5357710/17/images/1/INTRODUCTION+TO+PROJECT+FINANCE.jpg", Instrumental in facilitating creation of common legal terms for critical issues like completion guarantees, which all parties agree to abide by. Project update. "name": "Pre-completion risks and mitigation", "contentUrl": "https://slideplayer.com/slide/5357710/17/images/75/The+role+of+World+Bank%3A+WB+involvement+assured+sponsors+the+much+needed+protection+against+the+political+risk..jpg", Agency conflicts between sponsors and creditors: Distribution of cash flows, re-investment, and restructuring during distress, Moral hazard (such as risk shifting and debt shifting) encouraged by full recourse nature of debt to sponsor, Cash Flow Waterfall mechanism reduces potential conflicts in distribution and re-investment of project revenues, Legally/economically separate project company eliminates potential for risk shifting and debt shifting, Concentrated debt ownership is preferred (i.e. "name": "How Does It Create Value", However, the spot market for aluminum is very thin for Gov\u2019t to divert and easily sell the output. }, 127 Contracting and Project Finance Lecture Notes, Program on Project Appraisal and Risk Management, May 16-June , Duke Center for International Development. "name": "Why use Project Finance", "description": "Calpine Corporation. "@type": "ImageObject", Value creation by contractual structure:An introduction to risk management Risk management defined Sources of risks Who bears risk? Organizational risks: Incentive problems relating to management or workers. "contentUrl": "https://slideplayer.com/slide/5357710/17/images/93/Pre-completion+risks+and+mitigation.jpg", "contentUrl": "https://slideplayer.com/slide/5357710/17/images/87/Background.jpg", { ", OUTLINE What is Project Finance?How does project finance create value? "contentUrl": "https://slideplayer.com/slide/5357710/17/images/56/Case+examples+to+value+creation.jpg", Starting with equity: eliminate risk shifting, debt overhang and probability of distress (lenders\u2019 requirement). "description": "Solution. PRI providers are more competent in analyzing sovereign risks, whereas commercial banks in analyzing commercial risks. Joint venture projects with heterogeneous partners: Financially weaker partner cannot finance its share of investment through corporate borrowings, and needs project finance to participate. }, 128 }, 15 Covers the NPV of loss due to nonperformance over the life of the project. "description": "Seizure of cash flows (diversion) \u2013 low risk: Gov\u2019t may divert the aluminum and sell it to others. Financial risks. More equity commitment actually signals that sponsors perceive the project as right. Background Mozal is a $1.4 B aluminum smelter project in Mozambique. The project with potentially high returns and developmental impact for Chad was also aligned with WB\u2019s policy objectives. According to Harvard Law School, Oil will not lead to development in Chad without real participation, real transparency, and real oversight, none of which currently exists The revenue management plan also regarded as infringement of sovereign rights The sovereign rights controlled by undemocratic rulers versus people. Implications of a sudden major local currency devaluation in cases where the project revenue is in local currency and debt in foreign currency. "name": "Approaches to calculating the Cost of Capital in Emerging Markets", "@type": "ImageObject", }, 99 Risk-return trade-offs may enable integrative (not necessarily competitive) negotiations among different stakeholders and may create value in a project setting. "description": "Supply risk: Uncertainty regarding the availability of the input supplies throughout the life of the project. Value creation by organizational structure: Agency CostsProblems Structural Solutions: 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. ", Vertical integration is effective in precluding opportunistic behavior but not at sharing risk. "description": "Approaches to calculating the Cost of Capital in Emerging Markets. "contentUrl": "https://slideplayer.com/slide/5357710/17/images/28/Value+creation+by+contractual+structure%3A+An+Introduction+to+Risk+Management.jpg", "width": "800" "name": "A simplified project structure example:", "name": "INTRODUCTION TO PROJECT FINANCE", Environmental and social risks mostly remain with Chad. Syndicate of banks and\/or financial institutions provide debt. "@type": "ImageObject", "width": "800" ", Long term contracts such as supply and off take contracts: these are more effective mechanisms than spot market transactions and long term relationships. "description": "How does project finance create value Project Valuation. "description": "Problems. "contentUrl": "https://slideplayer.com/slide/5357710/17/images/81/Assessment+of+Project+Risks+and+Returns%3A+Sponsors+%28Exxon+Mobil%29.jpg", "@type": "ImageObject", Preserves corporate debt capacity. 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. "description": "Back-loaded cash flows to Gov\u2019t may be perceived as unfair and may result in expropriation. Not a major risk since the proceeds will be kept at an overseas trustee. }, 79 Case examples to value creationHow project structure may help: A hybrid structure was crafted that combined elements of both project and corporate finance: Project Finance: Calpine project financed a portfolio of plants rather than a single plant. "description": "Timing 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. }, 116 Value creation by contractual structure: Sovereign risks:Solution Political risks: Likelihood of occurrence of political events like wars, labor strikes, terrorism, etc. "contentUrl": "https://slideplayer.com/slide/5357710/17/images/115/Sovereign+risks+Political+events%3A+Political+instability.jpg", }, 78 Major project contracts:Construction Contract: A contract defining the turnkey responsibility to deliver a complete project ready for operation (a.k.a. "description": "Inflation risk: Relative changes in the price of inputs and output may adversely affect the project. In Japan, it needed to either obtain permit from the government for building new stations, or contract or partner with other companies to obtain access to the existing ones. "description": "Solution. ", Agency costs, debt overhang, risk contamination, risk mitigation. "@type": "ImageObject", Similarly, the South African ECA may be more willing to bear the political risk than banks do because it attaches a higher value to the project in order to be able to promote the south African exports. }, 89 "description": "Problems. Recap. "name": "OUTLINE What is Project Finance", "width": "800" 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. Legal instability. This reduced legal and other fees, transaction costs, and saved time. "@type": "ImageObject", Besides, the project structure was designed in such a way to allow for higher interest payments when sales increase, minimizing the cash balances. "width": "800" "@context": "http://schema.org", EPC contracts for the downstream facilities and pipelines were planned to put out to bid to a consortia of leading international contractors. ", "@type": "ImageObject", Process failures. Output purchasers and input suppliers can also share the risks as they experience variability in their markets. 2. When the benefits of above told co-insurance outweighs cost of risk contamination "description": "Export system was the riskiest part of the project. Sovereign risks and mitigationForce Majeure risk: Likelihood of occurrence of political events like wars, labor strikes, terrorism, or nonpolitical events such as earthquakes, etc. "description": "WB involvement also ensured that sponsors did not abandon the project due to huge political risks and looked instead for safer opportunities in other countries, leading to a missed opportunity for Chad. "name": "Case examples to value creation", for early detection of problems. Case analyses. "@type": "ImageObject", "description": "Even if the project generates promised revenues for Chad, Chad might not gain on an incremental basis, as it will no longer be eligible to certain types of developmental funding due to increased revenues. ", Project Valuation Case analyses Recap OUTLINE What is Project Finance?How does project finance create value? { that constitute the field system If you wish to download it, please recommend it to your friends in any social system. "contentUrl": "https://slideplayer.com/slide/5357710/17/images/48/Case+examples+to+value+creation.jpg", Post-completion: market, supply/input, throughput. Option to increase the production. WB states in its web site that it remains in dialogue with the Chadian authorities, and is determined to safeguard the oil revenues intended for poverty reduction programs included in its original agreement with Chad, while recognizing the fiscal strains currently experienced by the government of Chad . "@type": "ImageObject", "contentUrl": "https://slideplayer.com/slide/5357710/17/images/7/Major+characteristics%3A.jpg", Most assumptions of CAPM fail in this environment. { "description": "How project structure may help: Decided on high leverage and project finance structure to help: limit the amount of equity they needed to invest to an acceptable size. "@type": "ImageObject", Tighter covenants limit managerial discretion and enforces greater discipline via better monitoring. agency or tax reasons that exclude equity as a valid option. Option to sell the excess capacity to future projects in the area. }, 5 Why does structure matter?Structural decisions may affect the existence and magnitude of costs due to market perfections: * Agency conflicts * Financial distress * Structuring and executing transactions * Asymmetric information between parties involved * Taxes Value Creation Governance Structure Organizational Structure Contractual Structure Petrozuata and Oil Field Development ProjectBackground Why use project finance? "description": "Issues: Project Risks: The project had considerable political, financial, industrial (price and reserve volatility), and transportation related risks largely due to the unique region it was located. "name": "Value creation by contractual structure:", share the project risk with debt holders. Project design itself for risk mitigation (elements of production process, technology used, etc.) "contentUrl": "https://slideplayer.com/slide/5357710/17/images/97/Post-completion+risks+and+mitigation.jpg", How Does It Create Value?Drawbacks of using Project Finance Value creation by Project Finance Organizational structure Agency costs, debt overhang, risk contamination, risk mitigation Contractual structure Structuring the project contracts to allocate risk, return, and control Governance structure Costs and benefits of debt-based governance Case examples to value creation "description": "Helps uncover the information about the project, as well as sponsors and governments involved, which may not be readily available to lenders. { "name": "Cost of capital calculation*", "width": "800" "width": "800" Revenues, costs, and debt in same currency (indexing if they are not in the same currency) Market-based hedging of currency risks (though not widely used) For protection from a sudden major devaluation, a revolving liquidity facility can be utilized to cover the time lapse between the devaluation and the subsequent increase in inflation that should compensate the project company for debt payments. "@type": "ImageObject", Ignores imbedded options. ", The crude oil prices for the last 18 months ranged from $9 to $42, averaging $20 per barrel, which, even after discounted for the lower grade, was considerably higher than the projects $5.20 exploration and development costs. }, 93 Post-completion risks: Market risk, supply risk, throughput risk, and force majeure. Gives the cost of capital of an average project in the country in $). Conflicts between sponsors and government: Expropriation through either asset seizure, diversion, or creeping. "contentUrl": "https://slideplayer.com/slide/5357710/17/images/117/Sovereign+risks+mitigation.jpg", }, 13 During construction, the supplies such as water, electricity, hydrogen supply and diluent supply will all be contracted to firms owned by the Venezuelan Gov\u2019t. It is very difficult to estimate Beta with the World portfolio. "contentUrl": "https://slideplayer.com/slide/5357710/17/images/14/Drawbacks+of+Using+Project+Finance+Structure%3A.jpg", "@type": "ImageObject", { Major project contracts:The Offtake Contract: 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 Can take various forms, such as Take or Pay Contract: Power Purchase Agreement (PPA) Input Supply Contract: The Offtake Contract for the input supplier Provides the Project Company the security of input supplies on a pre-agreed pricing basis The terms of the Input Supply Contract are usually crafted to match those of the Offtake Contract (such as input volume, length of contract, force majeure, etc.) Outright seizure of assets very unlikely: The scale of the project relative to the size of the poor economy (9% of GDP), combined with short-term survival concerns may be tempting for a shortsighted Govt to expropriate, Govt wouldn't want to curb the investments, because they are interested in development, Govt cannot afford an outright seizure, due to potential reactions from WB/IFC, as this would jeopardize the much needed future development funds, Following a direct seizure, international suppliers may not be willing to work with the Govt, and Mozambique does not have local suppliers of the raw materials to go on with the business alone. "@context": "http://schema.org", "description": "Drawbacks of using Project Finance. "width": "800" ", { Single cash flow stream and separate ownership provides easier monitoring. }, 100 Risk management: Protection of BP Amoco\u2019s balance sheet from risk contamination or distress costs from investing in a risky asset. The project would use Telstra\u2019s two landing stations at Australia. Value creation by organizational structure: Agency CostsProblems Structural Solutions: Agency conflicts between sponsors and creditors: Distribution of cash flows, re-investment, and restructuring during distress Moral hazard (such as risk shifting and debt shifting) encouraged by full recourse nature of debt to sponsor Cash Flow Waterfall mechanism reduces potential conflicts in distribution and re-investment of project revenues Legally/economically separate project company eliminates potential for risk shifting and debt shifting Concentrated debt ownership is preferred (i.e. }, 38 ", 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. "width": "800" Involvement of multilateral\/bilateral agencies. 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. Project financing for a field development project would also not be a viable financing option, as the lenders generally would be reluctant to finance until after all reserves are proven and capable of production. }, 115 "@type": "ImageObject", Alusaf was the subsidiary of the South Aftrican Gencor group, which was the world\u2019s fourth largest aluminum producer. Costs and benefits of debt-based governance. { Governance structure. "contentUrl": "https://slideplayer.com/slide/5357710/17/images/71/Background.jpg", "description": "Historically formed to finance large-scale projects. "width": "800" Mozal is a $1.4 B aluminum smelter project in Mozambique. An undertaking to pay a long-run average price. ", As for an interim management team, sponsors would also be made equal partners in control, regardless of individual ownership shares. Additionally, foreign currency may be needed to import materials, equipment, etc. Reputable contractor. Force majeure risk: Likelihood of occurrence of events like wars, labor strikes, terrorism, or nonpolitical events such as earthquakes, etc. 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. { "width": "800" "@type": "ImageObject", "width": "800" Acts as a mediator between the governments and sponsors to ensure all issues are addressed and handled properly. Maraven also had significant production technology and experience. A fixed price growth path. Instrumental in harmonizing the legal structures of Mozambique and South Africa to create an agreed-upon basis for dispute resolutions. Sovereign risks and mitigationExpropriation risk: Sovereign risk in the form of governments direct seizing of project assets, project cash flows (diversion), or changing tax policy (creeping) Risk of Governments changing the currently preferential tax and royalty treatment Possible negative influence of Govt on the effective functioning of offshore proceeds account History of nationalization in the 1970s Govt cannot afford to risk the future funding opportunities for the planned series of upcoming projects by getting involved in any form of expropriation The Govt owns a serious portion of the assets anyway (PDVSA and Maraven as sponsors) Any expropriation attempt may face a retaliation from US where PDVSA has assets (CITGO) Govt interests aligned with the projects success, as Govt receives tax and royalty payments, as well as benefits of employment opportunities created and access to the refining technology Project output syncrude has a narrow market limiting Governments motivation for a diversion attempt "width": "800" "width": "800" Major characteristics. }, 14 Besides, host government may grant the project tax holiday , which provides sponsors exemptions from taxation. Cost of capital calculation**C. Harveys International Cost of Capital Calculator "width": "800" Costs: The high-yield market was thinner and more volatile compared to investment grade market, creating pricing and availability risk. Field development was the less risky part of the entire project for the sponsors, because upstream operations including field development and production was one of the core business areas where they were very strong at. After these reforms, WB and IMF permitted debt relief to Chad. = Revenues \u2013 Material \/ service costs \u2013 Depreciation. Completion bonuses\/penalties. Value creation by Project Finance. "width": "800" "name": "Project Update After WB approved the deal, President Deby used part of the proceeds to buy weapons. }, 114 { Assuming production level of 120,000 BPCD and 35 years project life, 7% of these reserves is sufficient to sustain the project Variability in the available crude oils quality was not deemed to be significant to reduce the efficiency of upgraders Additional value creation for Conoco from corporate perspective: In addition to being an equity holder in the project, Conoco would also benefit from low-cost reserves and long-run supply of crude oil the project would provide (with off-take contracts) for its refinery business
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