Chad-Cameroon Pipeline: Summary. Did the project finance create value for the sponsors? Gross Value: at least $15 million + value of time structuring the deal. (It must have been worth it to spend the time and pay the $15 million in fees.)
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Chad-Cameroon Pipeline: Summary • Did the project finance create value for the sponsors? • Gross Value: at least $15 million + value of time structuring the deal. (It must have been worth it to spend the time and pay the $15 million in fees.) • The fact that the sponsors used corporate finance for the field system suggests that transaction costs of PF are high. The incremental benefit of arranging a PF for the field system is exceeded by the incremental transaction cost. • Important sources of the value • World Bank/ECAs participation mitigated political risk. The RMP constrains the party (Chad gov’t) who controls the risks. • Non-recourse debt shielded sponsors credit exposure. • PF structure allowed the use of higher leverage (higher value of tax shields, and reduced equity exposure). • Compared to the Busang/Bre-X deal in Indonesia, Chad and Cameroon all got a pretty good deal. • But the cash flows that Chad receives is “back-loaded”—it gets more of the cash flows later, rather than earlier. In other words, it ends up bearing more of the reserve risk than the sponsors.
Classification of Project Risks (No Market Exists) Force Majeure (politicalExpropriation(taxes, regulation, enforcement)Currency ConvertibilityCurrency Devaluation Market Risks(e.g., country) Demand = f(GDP)Inflation Macroeconomicandsome SovereignRisks Exchange Rates Interest Rates Oil price(Market Exists) Operator PerformanceLand Acquisition/PermitsCost Over-run/DelayReserve riskSupport Roads (Infrastructure)ExpropriationEnvironmental Risks Construction,Operating,andsome Sovereign Risks Project SpecificRisks Force Majeure(Acts of Nature) Low High Ability to Control
Generic Risk Management Strategies (No Market Exists) INSURE(with political risk insurance)ALLOCATE(with contract and profit sharing)orDETERwith WB/IFC participation Market Risks(e.g., country) BEAR HEDGE(Market Exists) INSURE OR DIVERSIFY ALLOCATE(with contracts) Project SpecificRisks Influence Low High Ability to Control
Principles of Risk Management • Allocate risk to the party that controls the risk or had the greatest impact on its outcome (effectiveness). • Allocate risks to the party that can bear them at least cost (efficiency). • When possible and cost effective to do so, write a detailed contract specifying actions, quality, and performance. Contracts work best when the risks are identifiable, outcomes are verifiable, and contracts are enforceable. Predictable: note the difference between risk (known distributions) and uncertainty (unknown distributions) Verifiable: note the role of asymmetric information. Enforceable: note the importance of legal systems, property rights, and enforcement mechanisms. • When negotiation, contracting, and other transaction costs make complete contracting unfeasible, allocate residual risk and return to align incentives and induce optimal behavior. • If possible, allocate asymmetric, downside risks to debt holders; allocate symmetric and upside risks to equity holders.
Murphy’s Law Applied to Project Finance • Nature always sides with the hidden flaw. • Anything you try to construct will take longer and cost more than you thought. • If everything seems to be going well, you don’t know what is going on. • The unexpected will always happen. Source: Fortin, R. Jay, Defining force majeure, Project and Trade Finance, Jan. 1995.
Murphy’s Law Applied to Project Finance • Project risks end up on those least able to resist them.