Project Finance Is The Long Term
Project Finance Is The Long Term
Project Finance Is The Long Term
Project finance 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. Usually, a project financing
structure involves a number of equity investors, known as sponsors, as well as a syndicate of banks that
provide loans to the operation. The loans are most commonly non-recourse loans, which are secured by the
project assets and paid entirely from project cash flow, rather than from the general assets or creditworthiness
of the project sponsors, a decision in part supported by financial modeling.[1] The financing is typically secured
by all of the project assets, including the revenue-producing contracts. Project lenders are given a lien on all of
these assets, and are able to assume control of a project if the project company has difficulties complying with
the loan terms.
Generally, a special purpose entity is created for each project, thereby shielding other assets owned by a
project sponsor from the detrimental effects of a project failure. As a special purpose entity, the project
company has no assets other than the project. Capital contribution commitments by the owners of the project
company are sometimes necessary to ensure that the project is financially sound. Project finance is often more
complicated than alternative financing methods. Traditionally, project financing has been most commonly used
in themining, transportation, telecommunication and public utility industries. More recently, particularly in
Europe, project financing principles have been applied to public infrastructure underpublic–private
partnerships (PPP) or, in the UK, Private Finance Initiative (PFI) transactions.
Risk identification and allocation is a key component of project finance. A project may be subject to a number of
technical, environmental, economic and political risks, particularly indeveloping countries and emerging
markets. Financial institutions and project sponsors may conclude that the risks inherent in project
development and operation are unacceptable (unfinanceable). To cope with these risks, project sponsors in
these industries (such as power plants or railway lines) are generally completed by a number of specialist
companies operating in a contractual network with each other that allocates risk in a way that allows financing
to take place.[2] The various patterns of implementation are sometimes referred to as "project delivery
methods." The financing of these projects must also be distributed among multiple parties, so as to distribute
the risk associated with the project while simultaneously ensuring profits for each party involved.
Project finance shares many characteristics with maritime finance and aircraft finance; however, the latter two
are more specialized fields.
Contents
[hide]
1 Basic scheme
2 Complicating
factors
3 History
4 See also
5 References
6 External links
[edit]Basic scheme
Acme Coal Co. imports coal. Energen Inc. supplies energy to consumers. The two companies agree to build a
power plant to accomplish their respective goals. Typically, the first step would be to sign a memorandum of
understanding to set out the intentions of the two parties. This would be followed by an agreement to form
a joint venture.
Acme Coal and Energen form an SPC (Special Purpose Corporation) called Power Holdings Inc. and divide the
shares between them according to their contributions. Acme Coal, being more established, contributes
more capital and takes 70% of the shares. Energen is a smaller company and takes the remaining 30%. The
new company has no assets.
Power Holdings then signs a construction contract with Acme Construction to build a power plant. Acme
Construction is an affiliate of Acme Coal and the only company with the know-how to construct a power plant in
accordance with Acme's delivery specification.
A power plant can cost hundreds of millions of dollars. To pay Acme Construction, Power Holdings receives
financing from a development bank and a commercial bank. These banks provide a guarantee to Acme
Construction's financier that the company can pay for the completion of construction. Payment for construction
is generally paid as such: 10% up front, 10% midway through construction, 10% shortly before completion, and
70% upon transfer of title to Power Holdings, which becomes the owner of the power plant.
Acme Coal and Energen form Power Manage Inc., another SPC, to manage the facility. The ultimate purpose
of the two SPCs (Power Holding and Power Manage) is primarily to protect Acme Coal and Energen. If a
disaster happens at the plant, prospective plaintiffs cannot sue Acme Coal or Energen and target their assets
because neither company owns or operates the plant.
A Sale and Purchase Agreement (SPA) between Power Manage and Acme Coal supplies raw materials to the
power plant. Electricity is then delivered to Energen using a wholesale delivery contract. The cashflow of both
Acme Coal and Energen from this transaction will be used to repay the financiers.
[edit]Complicating factors
The above is a simple explanation which does not cover the mining, shipping, and delivery contracts involved in
importing the coal (which in itself could be more complex than the financing scheme), nor the contracts for
delivering the power to consumers. In developing countries, it is not unusual for one or more government
entities to be the primary consumers of the project, undertaking the "last mile distribution" to the consuming
population. The relevant purchase agreements between the government agencies and the project may contain
clauses guaranteeing a minimum offtake and thereby guarantee a certain level of revenues. In other sectors
including road transportation, the government may toll the roads and collect the revenues, while providing a
guaranteed annual sum (along with clearly specified upside and downside conditions) to the project. This
serves to minimise or eliminate the risks associated with traffic demand for the project investors and the
lenders.
Minority owners of a project may wish to use "off-balance-sheet" financing, in which they disclose their
participation in the project as an investment, and excludes the debt from financial statements by disclosing it as
a footnote related to the investment. In the United States, this eligibility is determined by the Financial
Accounting Standards Board. Many projects in developing countries must also be covered with war risk
insurance, which covers acts of hostile attack, derelict mines and torpedoes, and civil unrest which are not
generally included in "standard" insurance policies. Today, some altered policies that include terrorism are
called Terrorism Insurance or Political Risk Insurance. In many cases, an outside insurer will issue
a performance bond to guarantee timely completion of the project by the contractor.
Publicly-funded projects may also use additional financing methods such as tax increment financing or Private
Finance Initiative (PFI). Such projects are often governed by a Capital Improvement Plan which adds certain
auditing capabilities and restrictions to the process.
[edit]History
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, and was widespread in the US oil and
gas industry during the early 20th century. However, project finance for high-risk infrastructure schemes
originated with the development of the North Sea oil fields in the 1970s and 1980s. For such investments,
newly created Special Purpose Corporations (SPCs) were created for each project, with multiple owners and
complex schemes distributing insurance, loans, management, and project operations. Such projects were
previously accomplished through utility or government bond issuances, or other traditional corporate finance
structures.
Project financing in the developing world peaked around the time of the Asian financial crisis, but the
subsequent downturn in industrializing countries was offset by growth in the OECD countries, causing
worldwide project financing to peak around 2000. The need for project financing remains high throughout the
world as more countries require increasing supplies of public utilities and infrastructure. In recent years, project
finance schemes have become increasingly common in the Middle East, some incorporating Islamic finance.
The new project finance structures emerged primarily in response to the opportunity presented by long term
power purchase contracts available from utilities and government entities. These long term revenue streams
were required by rules implementing PURPA, the Public Utilities Regulatory Policies Act of 1978. Originally
envisioned as an energy initiative designed to encourage domestic renewable resources and conservation, the
Act and the industry it created lead to further deregulation of electric generation and, significantly, international
privatization following amendments to the Public Utilities Holding Company Act in 1994. The structure has
evolved and forms the basis for energy and other projects throughout the world.
[edit]See also
1. ^ See generally, Scott Hoffman, The Law & Business of International Project Finance (3rd ed. 2007,
Cambridge Univ. Press).
2. ^ a b Marco Sorge, The nature of credit risk in project finance, BIS Quarterly Review, December 2004, p. 91.
[edit]External links
http://www.scribd.com/doc/14941260/Role-of-Banks-in-Indian-Economy-Report#fullscreen:off