Project Finance for the International Petroleum Industry

Robert Clews

• Editorial: Academic Press
• Año: 2016
• ISBN:
  9780128005293
• Categoría: Business
• Categoría: Finanza d'impresa

This overview of project finance for the oil and gas industry covers financial markets, sources and providers of finance, financial structures, and capital raising processes. About US$300 billion of project finance debt is raised annually across several capital intensive sectors—including oil and gas, energy, infrastructure, and mining—and the oil and gas industry represents around 30% of the global project finance market.

With over 25 year's project finance experience in international banking and industry, author Robert Clews explores project finance techniques and their effectiveness in the petroleum industry. He highlights the petroleum industry players, risks, economics, and commercial/legal arrangements. With petroleum industry projects representing amongst the largest industrial activities in the world, this book ties together concepts and tools through real examples and aims to ensure that project finance will continue to play a central role in bringing together investors and lenders to finance these ventures.

• Combines the theory and practice of raising long-term funding for capital intensive projects with insights about the appeal of project finance to the international oil and gas industry
• Includes case studies and examples covering projects in the Arctic, East Africa, Latin America, North America, and Australia
• Emphasizes the full downstream value chain of the industry instead of limiting itself to upstream and pipeline project financing
• Highlights petroleum industry players, risks, economics, and commercial and legal arrangements

Part I

Introduction to Project Finance

Introduction

Chapter 1: The Characteristics of Project Finance

Chapter 2: Project Finance Structures and Techniques

Chapter 3: Sources of Finance and the Global Project Finance Markets

Chapter 4: Commercial Banks and Syndicated Lending

Introduction

The objective of Part I of this book is to provide a general introduction to project finance and to explain the role of this financing technique in the context of the wider global financial markets. Project sponsors are usually confronted with a range of financing options when seeking to raise funds for their projects. It is, thus, important to understand how finance is raised generally for projects and then move on to explore the types of circumstance when project finance is chosen as the preferred option.

To see why project finance is used as a funding technique for oil and gas projects, it is firstly necessary to explain what project finance actually means. This form of financing is based on the concept of lenders providing debt to a specific project and does not rely solely on the corporate resources of the sponsors or the underlying value of the project assets. Lenders therefore place a significant degree of reliance on the performance of the project itself and, as a result, they will spend a considerable amount of time examining the viability of the project and its sensitivity to adverse risks. Chapters 1 and 2 will explore the characteristics and features of project finance and how the involvement of lenders in projects can influence corporate, commercial and financial structures.

It is important to examine which institutions are involved in providing funds in the project finance market, as well as understanding the basic principles of project finance. These institutions influence the structures and terms of project finance transactions to a significant degree and sponsors looking to raise project finance will need to understand the nature and dynamics of the project finance markets. Chapter 3 describes the main characteristics of this global market. It will be seen that international commercial banks and the syndicated loans market play a central role in oil and gas project finance. Chapter 4 will thus cover in more detail the role of commercial banks in the project finance markets. Many of the features of project finance are derived from the wider global syndicated loans market and hence the features and functions of this market will also be examined.

The four chapters of Part I will lay the foundations upon which can be built the application of the funding technique to the oil and gas industry. Having understood the importance of lender reliance on project cashflows to pay interest and repay loan principal, the need to understand project risks and contractual structure should become clear. Part II will then lead in to a more detailed examination of the risks and contracts which are typically encountered in the various segments of the international petroleum industry.

Chapter 1

The Characteristics of Project Finance

Abstract

Project finance is a funding technique that looks to the cashflows generated by a project to provide investor returns and lenders’ debt service. There are a number of core principles that characterise this form of financing and, once understood, these can be applied to raise capital for almost any type of project. The purpose of this chapter is to describe these characteristics in general terms and explain the principles, which underpin this method of financing. These general concepts can then be applied more specifically to project finance for the petroleum industry.

Keywords

bankability

capital budgeting

capital investment

capital structure

cashflow lending

cashflow modelling

cover ratio

debt capacity

due diligence

investment appraisal

limited recourse

project finance

risk analysis

risk assessment

Chapter Outline

1.1 Introduction 3

1.2 Raising Finance for Large Projects 4

1.3 Using Project Finance to Raise Capital 5

1.4 Risk Analysis and Risk Mitigation 8

1.4.1 Lender Risk Assessment 9

1.4.2 Project Bankability 10

1.4.3 Risk Mitigation and Project Contracts 11

1.5 Project Economics, Capital Structure and Debt Capacity 12

1.5.1 Capital Structure, Debt Capacity and Cover Ratios 13

1.5.2 Determining the Level of Cover That Lenders Require 15

1.5.3 Financial Structuring 15

1.6 The Project Finance Process 16

1.6.1 Project Finance Participants 16

1.6.2 Stages of Project Financing 18

1.6.3 Project Financing Process Management and Timing 20

1.1. Introduction

Project finance is a funding technique that looks to the cashflows generated by a project to provide investor returns and lenders’ debt service. There are a number of core principles that characterise this form of financing and, once understood, these can be applied to raise capital for almost any type of project. The purpose of this chapter is to describe these characteristics in general terms and explain the principles which underpin this method of financing. These general concepts can then be applied more specifically to project finance for the petroleum industry.

Section 1.2 reviews the options and decisions faced by the sponsors of large projects when seeking to raise capital to develop their schemes. There are many potential sources of funding for projects and the different options can have a significant impact on project economics and viability. Project sponsors will therefore want to carefully assess the advantages and disadvantages of all the possible funding combinations.

Section 1.3 then moves on to consider how project finance is used to raise capital for projects and the core principles which form the foundations of this method of funding. It will be seen that two core activities lie at the heart of the project finance process, namely: the analysis of project risks and the forecasting of project cash flows.

Section 1.4 covers in more detail the importance of debt in project finance and the methods used by project lenders to analyse and assess project risks. The concept of ‘bankability’ is introduced as well as the methods used in project finance to mitigate project risks to an acceptable level.

Section 1.5 explains the importance of the quantitative analysis of projects particularly project cashflows and capital structure. The various debt coverage ratio measurements are introduced together with the use of these ratios in the financial structuring process.

Finally, having looked at the most important components of project financing, Section 1.6 moves on to examine the processes which are usually followed to structure, execute and complete project finance transactions.

1.2. Raising finance for large projects

Capital investment is a vital economic activity and represents an important constituent of the world’s economic output. According to conventional economics, insufficient investment in a nation’s capital stock will result in falling economic output and ultimately a poorer society. Investment is therefore nationally important and governments attach great political significance to capital spending on infrastructure projects such as roads, airports, energy infrastructure and so on. Despite the economic and political importance of capital investment the amount spent by different countries is highly uneven. Globally, an average of around 30% of the GDP is spent on capital projects. This varies, however, from a low of as little as 10% to a high of over 50% of GDP. In the United States, for instance, capital investment by the private sector totalled around US$ 3,000 billion in 2014 representing approximately 18% of GDP.

Governments have traditionally played an important role in capital investment either directly through the public sector spending or indirectly through the state funding of capital projects. In many centrally planned economies, for instance, capital investment has traditionally been undertaken almost exclusively by the state with little participation from the private sector. During 1980s private companies started to play a much greater role in many parts of the economy which had previously been managed by the public sector. In parallel, private finance also started to replace central government funding of capital projects, which had traditionally been financed through taxation and borrowing. This trend towards higher private sector involvement in the capital investment and financing is largely responsible for the rapid growth of project finance in the period following the initial 1980s privatisations.

Whether the public or private sector is responsible for capital spending a proper assessment should be made of the need for the investment. A variety of tools and techniques are commonly used to assess the attractiveness of investment opportunities and this process of assessment and selection of investment projects is known as ‘capital budgeting’. Capital budgeting makes use of various investment appraisal methods, which typically rely on the assessment of the profitability of opportunities after taking account of the time value of money.¹ The project cash flows are discounted at an appropriate rate, after which a variety of parameters are calculated to guide the investment decision. A more detailed discussion on these investment appraisal parameters is provided in Chapter 2.

Once a decision has been made to invest in a project, finance has to be raised to pay for the investment. Huge sums of money are involved in capital investment, and finance thus plays an essential role in ensuring the long-term capital sustainability of a nation’s economy. Like any procurement activity, raising finance for large projects involves selection between alternatives, careful planning and a thorough knowledge of the available options. For most viable investment opportunities there is usually a wide variety of financing options, project finance being only one of a number of alternatives. The reasons for using project finance to fund capital investment will be explored further in the following section.

The discussion so far has concerned capital investment at a general level. The international petroleum industry is one of the most capital-intensive sectors of the global economy and enormous investment is required just to maintain existing levels of production of petroleum products. The projected capital spend by the industry over the next decade is estimated to be US$ 700 billion per annum with the largest companies in the sector having annual capital budgets in excess of US$ 30 billion just by themselves. For the vast majority of projects in the oil and gas industry finance is provided from internal sources or corporate level funding. These more traditional sources of finance are examined in more detail in Section 14.3.

1.3. Using project finance to raise capital

In the previous section it was shown that finance plays an essential role in successful long-term investment and that sponsors of large capital-intensive projects are fac...