project finance deals

project finance deals

The Fundamentals of Project Finance Deals: A Comprehensive Analysis

1. Introduction to Project Finance Deals

In recent inquiries of project financiers and the support services such as legal, accounting, and insurance professionals, as well as the ECAs and PRIs, on what constitutes project finance, however, reveals a lack of consensus. The definition of robust parameters is still needed. Despite this lack of consensus, there are certain basic principles that must be adhered to when arranging a project finance deal, whether such deals are in the form of reserves for commercial banks, in-loan syndicates, or even funded through the capital markets themselves. In order to identify what constitutes a project finance deal, we begin with the traditional classic or corporate style of financing that project finance has sought to replace in recent years.

Project finance is a technique used by many large commercial banks and securities houses in funding a vast range of non-resource, large infrastructure, and public sector industrial projects. Project financing has become the preferred method of financing for most large, long-term industrial projects, particularly in developing countries. The traditional method of financing them, whereby the project was financed on the balance sheet and through corporate debt, has some inherent disadvantages which are overcome by utilizing a narrow range of bank debt products and the effort of the capital markets.

2. Key Players and Stakeholders in Project Finance Deals

Financing institutions form a guidable risk at the beginning of the first contract to which any financial institution provides its guarantee. Financial institutions do not constitute a permanent entity, as will be mentioned later. It is important to observe that the proportion of invested capital from the start of project implementation is not the smallest present. However, when the same occurs provision of guarantee, interest rates go down, thereby enabling a greater amount of amortizations and solicited interest. As a consequence, less collateral is required by sponsors and, as previously mentioned, the contribution of partners is required by a business group with the same go-between of the support level set at a lower limit in the absence of loan guarantee. Determine an enterprise cash-flux combination that indicates the amounts of collateral required to face possible cash unrelatedness because of unusual characteristics. Monitor the site to circumstance, business after crisis, arbitration management solutions and temporary reorientation of the business and simplicity during its reprivatization. The telephone company should guarantee the loyalty faith of employees that there will be no significant changes in regard to banking occurred in the official project, with the exception of those occurring in stochastic business conducted in financial market. The company did not follow the same closed line because a control clause of income may not have been enabled in project finance. Banks desire to acquire a stake at the lowest possible price in companies to which they have given possibility to borrow. Therefore, in the upstream period that has the possible guarantee allowance, it is the guarantee of the semi-duty of the semi-backup type, whose exercise may become mandatory during certain temporal events. Future recognition amount is payable in the future if financial schedule is verified. Banks will call upon this duty as a sponsoring term. Upon failure, it is likely that the firm concerned will from the point of view of the bank agree to a limited non-serve clause. Under the circumstances, however, the banks will enforce the call and obtain additional collateral mentioned before, to begin unlocking the credit and funding potential necessary for the project.

Sponsors of a primitive deal are always the ones capable of putting their capital at risk. Even if the investment is taken by a corporation other than the one controlling the public partner, we can consider it as an investment outside public companies. Even when the investment is not supposed to be a straight risk for the economic group responsible for the operation of a project, as in the case in which there is some kind of system of bonuses or penalties in the payment mechanism, the company that makes the investment cannot go through significant difficulties and it can afford to have a loss incurred by the inadequate operation of the project associated with weak safety conditions. This is true concerning the accounting practices of the specific company. From the legal aspect, the public partner holds commitment over occupational safety in general. The biggest impetus for the sponsor to consider the implementation of Project Finance involves the necessity to have commitments made that provide for the availability and good operation of the underlying system that will mitigate over risky products. Such necessity is valid in the case of issues relative to government budget operational restriction. Since the proposed solution enables transfer of that necessity, but not necessarily its suppression, goes beyond mere budget issue relief. During negotiations, sponsors will be willing to assume an even greater degree of private risks in accordance to both management contract remunerations as well as their good operational results.

3. Structuring Project Finance Deals: Techniques and Considerations

In this chapter, we discuss how these basic principles and solutions are applied to each of the components of a project finance deal, including both pure project finance and associated financings, which are a common feature of many of the financing structures. To this end, we first describe some models for the structuring of the equity and the typical and targeted return on investment of this type of business, which aims to contribute to a progressive and graduated approach to the development of each megaproject in a way to limit the initial investment risk. After correlating these models with the general principles of economic-financial evaluation, the results are obtained for the indicators of economic and financial viability and, in an exploratory way, some requirements imposed by potential financiers that can be optimized. Using software for modeling and economic evaluation makes it easy, without loss of generality, to perform sensitivity analysis on the adopted indicators to identify the most critical variables in the definition of the investment’s economic viability.

Project finance is a structured financing technique that presents a number of variations and solutions that are tailored to specific projects, their sectors, and the types of investors targets, among other things. While these customized projects often require the development of special solutions to meet legal, economic, and implementation issues, there are a number of common denominators when it comes to the structure of a project finance deal. This part of the book seeks to cover the basic and advanced concepts of project finance such as security packaging, project-specific post-risk themes, industry-specific project silver themes, financable presales and off-takes, cash-control techniques, and sponsor financings.

4. Risk Management in Project Finance Deals

Many of the same opportunities in different applications of knowing-the-borrower value-creation and knowledge-asymmetry value-structure principles are also available to project finance investors—that is, real property value, business value, and creditor investment value are inherently amenable to contractual form, and legal, financial, and structural techniques. Ultimately, a transaction is partly a function of what the project sponsor and infrastructure consumers want to accomplish, and lastly a function of the express desires of the parties and their perceptions of the transaction risks. Say what you are going to say, say it, and say what you said. Four millennia of annotation don’t change things much.

Project Finance Submarkets

2. Benefits

1. Processes Contractual project arrangements allocate important investment, operating, regulatory, and operating control risks to individual parties of the project. They do so in a manner that generally respects (or is consistent with) the comparative advantage of the individual contractual parties: the cost of controlling the outside risk is allocated to the party that is best able to manage the external risk that party’s benefits. Thus, the inherent nature of a contractual arrangement involves the relationship between outside risks and free allocation, which in its most essential terms is the first and more universally utilized principle of corporate finance in the Modigliani-Miller paradigm.

The Allocative Role of Contract

Development Risk and the Formulation of Debt Financing

7. Operating and Maintenance Contractual Issues

6. Operating Risk

5. Market Demand Risk

4. Resource Risk-Supply and Maintenance Contracts

3. Technological Risk

2. Permitting and Other Political Risks A variety of administrative, legislative, and even judicial processes can affect project completion by actively blocking the project or by drastically altering its economic value. Political-administrative points of attack are generally reviewed by the project sponsor during the locational siting phase of the project. While the sponsor formulates the project siting position, substantial damage may have already occurred.

1. Construction Risk The most important characteristic project finance focuses on is the unique nature of the construction risk in established-contracting-technique projects. Construction risk includes the risk that cost overruns will occur during the construction period. This unique risk factor has encouraged the development of the guaranteed fixed construction price contract—which is often accompanied by a design-build, turnkey, EPC or lump palm construction contract guaranteeing that the project will be completed and functional by a specified time for a promised fixed price.

The Nature of Project Finance Risks: Principal-Investor Risks in Project Finance

Because of the reduced creditworthiness resulting from the relatively narrow focus of a project and the desire of all parties to minimize their financial exposure, it is critically important that project risks be identified, distributed, and managed in project finance.

Risks in Project Finance

5. Case Studies and Real-world Applications

The chapter also raises the discussion on the international market of renewable energy project finance deals. Although it has traditionally played a dominant role in this market, the economic crises that started in 2007 set Spain and Germany back to some extent, and new players emerged in the investors’ and the other counterparties’ outsourcing countries. These crises have made several governments review their renewable auction systems and their power market designs, mainly because of the excess of renewable assets in their markets, the position mismatches between consumers and producers, and the increase of rent-seeking behavior encouraged by the flaws in the regulatory design. The same crises also brought about the attempts to reduce the sovereign risk faced by foreign investors in renewable contract countries. This is necessary to address for the capital to flow, as the legal and political conditions surrounding these contracts and their cash flow generation prospects are of extreme importance for the ultimate investors’ decision to commit to the deal or not. The uncertainties associated with a misalignment of interests between the local and the foreign economy can even affect the overall risk assessment after the assets are in operation.

This chapter covers the fundamental types of contracts typically encountered in project financing deals. It begins by addressing first the power purchase agreements that represent the hallmark of energy projects. Then, it comprehensively covers the other crucial contracts, namely, the safety and health agreements, transmission interconnection agreements, EPC agreements, operation and maintenance agreements, and technical support agreements. More concretely, this chapter examines the requirements, operational characteristics, the pricing mechanisms deviating from the price-per-hour standard based on a traffic volume metric or a capacity charge, the advantages and disadvantages of each of these contracts, the market models, the quantitative criteria, and the unpredictability typical of the renewable industry, the potential political issues in long-term power purchase agreements, the cash flow waterfall of each of the contracts and how they relate, and some policy implications and considerations when drafting the contract and structuring the deal.