Project and Infrastructure Finance Slides Module2_Ver3

5/20/2018 Project and Infrastructure Finance Slides Module2_Ver3

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MODULE - 2

RISK EVALUATION IN PROJECTS

Structuring cannot be made with weak counter parties

High risk projects are those with earnings volatilityand not necessary low return projects


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Oman India Fertiliser Project (OIFR)

Promoters IFFCO

KRIBHCO

Scope Production of ammonia, urea

Oman Government to supply gas at 1/5th

of the Indian price

Products to be imported by IFFCO &

KRIBHCO

Problem Urea prices are volatile and range from

$80 to $200/tonne.

The breakeven price is $120/tonne

How to protect lenders?


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Oman-India Fertiliser Company S.A.O.C.

(Project Company)

Closed joint stock company

Ministry of Chemical & Fertilisers

Government of I ndia

Urea Offtake Agreement

Ministry of Oil & Gas

Sul tanate of Oman

IFFCO

69% GOI owned

Gas Supply Agreement Excess Ammonia Offtake

Agreement

Personnel Supply AgreementTurnkey EPC Contract Technical Services

Agreement

EPC Joint Venture Company

(EPC Contractor)

IFFCO

69% GOI

KRIBHCO

67% GOI

IFFCO

69% GOI

KRIBHCO

67% GOI

Snamprogetti

SpA, ItalyTechnip-Coflexip

France

50% 50%

Oman India Fertiliser Project Structure


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KRIBHCO/

IFFCO

OIFP

OMAN

Government

DSRA

DSRA

Receivables

Sale of Urea Excess/ShortfallOver $120/T Shortfall/ExcessOver $120 / T

Operating expenses

Lenders liabilities

Oman Govt. dues

Dues of KRIBHCO/IFFCO

DSRA = $40 million (max.)

Risks - Price


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Financing of Blue Sky Project

Project:Upgrading refineries of Petromina for production ofunleaded gasoline for domestic market to reduce

pollution

Structure:Offshore trustee borrowing structure

Sponsors:Petromina, Indonesia

Project Cost: $280 million

Project Debt: $200 million

Lead Arrangers: Mitsui & Co ($120 million from JBIC)

EPC Contractor: Toyo Engg.


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Financing of Blue Sky Project

Features: Mitsui offtakes certain products (notgasoline) from Petrominas existing five refineries,and pays the proceeds in $ to an Offshore Trust

established by JP Morgan and Petromina. The debt isrepaid through a priority waterfall mechanism. TheOffshore Trust is in New York.

Construction Risk: Absent as debt service is not

related to completion of the project. Not servicedthrough sale of products from the project.


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Agreements

1. Loan Agreements between the

Lenders and the Trustee

Loan provided to offshore trust

established by JP Morgan andPetromina at New York. This

receives sales proceeds from

Mitsui & Co and used to repay

debt.

2. Product sales and purchase

agreement between Petromina

and Mitsui

Petromina to supply certain

products from its existing

refineries to Mitsui. Mitsui pay

the proceeds in $ into the trust

3. Trust agreement between

Petromina and Trustee

Appointment of a Trustee in

New York who enters into a loan

agreement with lenders and

avails of the loan


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Agreements

4. Operators Agreement between

Petromina and lenders

a) Cash shortfall undertaking

by Petromina

b) Undertaking to enter into

various agreements

5. EPC Contract Agreement to supply machineryand technology

Risk MitigatedPolitical risk, Exchange risk, Construction Risk


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Risk Mitigation

1. Trustee borrowing structure

2. Five refineries located at different locations

3. Debt repayment even before operating

expenditure/capital expenditure

4. Presence of JBIC


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PERTAMINA

5 Refineries

including Cilacap

and Balongan

1. Cilacap Refinery2. Balongan Refinery

Plant Construction

EPC

Mitsui Trustee

Excess CashSale Proceeds ofLSWR/Decant Oil

Long term Offtake

Of LSWR/Decant Oil

Special Purpose Vehicle

(established by Mitsui)Commercial Banks

JBIC

Repayment Loan

Repayment Loan

Payment

of EPC

Cost

Lenders

Risks: Political

Exchange


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Project Financing Phu My3 company in Vietnam

Project: Power plant of 715MW

Sponsors: British Petroleum

Sembcorp Utilities

Kyushu Electric Power

Nissho Iwai

Features: BuildOperateTransfer (BOT)

Concession 23 years

Gas supply agreement with Petro Vietnam (PV)Power Purchase agreement with Electricity of

Vietnam (EVN)


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Features: Currency conversion / transfer agreement with

Vietcom Bank (Bank for Foreign Trade in

Vietnam)

Applicable law Singapore / rules of Internationallaw for all agreements

EPC Contract / O&M contract with Siemens

Cost: $412M

Debt / Equity: 3 : 1Debt Providers: ADB - $40M, JBIC - $99M, Bonds - $170M

Project Financing Phu My3 company in Vietnam


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Power Purchase Agreement (PPA) Capacity charges to cover fixed charges plus equity

return

Variable cost covered by energy charges Gas cost plus penal charges under gas supply

agreement due to offtaker

Capacity Utilisation 88%

Linking of power tariff to gas price


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Government Guarantees and Undertakings Agreement:

Government Guarantees

Full repayment of debt if contract is terminated byGovernment / default or breach by Government / Force

Majeure

Government if needed will substitute the project company

if agreement is breached

Guarantees for performance of EVNs PV

Continuity of local taxation to be applicable for project

Currency conversion and remittance

Assurance on nationalisation / expropriation Exemptions from certain Vietnamese laws and

compensation for law change

Risks - Price


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Financing of a new stadium for St.Louis cardinals

Promotors Cardinal base ball club

Advisers Bank of America Securities sports finance

Amount - $200.5 million private placement bond debt

Features - 20 year financing

cost $ 330 million

$130 million from St.Louis country / city of St.LouisConstruction of a Major League Baseball

(MOB) stadium

Financing aided by monetizing Contractually

Obligated Income (COI) (i.e) naming rights, luxurysuites, sponsorships, multi year contracts, club

seat premiums.

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Traditional Securitisation

Sponsor

SPV

Investors

Generates and sells receivables

Purchase proceedsSale of receivables

Loan / purchase proceedsTransfer of interest in receivables

This keeps sponsors financial transaction away from the deal through a dummy SPV

though sponsor company originates receivables by performing contracts

Isolate receivables from the bankruptcy / credit risk of the sponsor

But if sponsor who is also an executor becomes bankrupt COI would be affected

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Structure 2

Investors SPV

Lessor

St.Louis Cardinals

LLC

Loan proceeds

Security Interest

License to play Base ball

GroundLease

Owns exclusive rights on

dedicated property and generates

contracts / receivables and COI

1. Acts as servicing and marketing

agent for SPV

2. Agrees to play at the stadium

Dedicated property means those that originate COI

rights to naming, conduct activities, license luxury suites

And club seats, sponsorship rights.

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In case St.Louis cardinals LLC fail, SPV can always look for

another party to take over the role. St.Louis cardinals is only aservice provider.

But in the original securitisation, since sponsors originatesreceivables, the failure of sponsor would end the transaction.

Another alternative is a owners trust (any sports franchiseowner) taking the ground on lease and sub-lease it to SPVwith all rights. SPV transfers its interest dedicated propertythrough owners trust to investors and loans provided toowners trust.

In this case debt could be less as sponsors equity would bethere.

Risk - Promoter

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Oil / Gas Monetisation Structure

DSRA

FD/Investment

T&R A/C Gujarat Gas

SPV/GSPC

Operator

Bank

Interest Income

Top up

of DSRA

Shortfall

Receivables

Sale of Oil /

Gas

Sale of receivables

Advance purchase

consideration

Debt service Capex

Opex

GSPCs A/C

RiskBankruptcy risk

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Shipyard Finance

Shipyard Bank

Platform hire

companySponsor

Oil production

company

Loans / Guarantees

Platform

credit sale

Guarantee fee / principal /

interest / assignment of oil

revenues

Equity

Profit

Hire payments

assignment of

revenues

Platform hire

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Captive Leasing Company

Manufacturer Captive lessor Lessee

Bank

Asset sale

Cash 100%

Lease agreement

Assets

Loan

Assignment

of lease

proceeds

Deposit

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Financing of Iduapriem Gold Mines in AustraliaMinproc Engineers, Australia

Feasibility study

Iduapriem

IFC

Senior debt/non recourse

Subordinated debt

Standby facility

Banks

Hedging 1/3

of production

of Gold

Equity 20%

Construction

contractSponsors

80%$60.4 million

$8.4 million

$38.4 million

$17 million

$5 million

$30million

(Syndicated by IFC)

1. IFC is a equity investor, standby debt facility provider, senior debt lender and mezzanine lender.

2. The subordinate debt had royalty linked to Gold prices above $350 / ounce raising to 8% when

Gold in US $450 / ounce.

3. 50% of excess cash flow above $20 million / annum. Mandatory prepayment in inverse order of

maturity

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Gold Warrants

BanksGuarantee

Loan

Placer Pacific

Placer (Barbados) Misima Mines P Ltd

Political risk

GuaranteeEDC, Canada,

EFIC, Australia

Standby Gold loan Equity

Misima Mine

20% Government

5 year gold

warrantsRedemption

80%

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Structure of Power ProjectsPromoter

Company

EquipmentSupplier

Equity

Lenders

Fuel

Supplier

Contractor

Fuel

EPCContract

Electricity

Board

PPA

Trust & Retention A/c

Debt Reserve

Loan Repayment+ Interest

Guarantees from

State/Cent. govts

Overflow

Revenues

ExcessProfits

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Gas Monetisation

Trust RIL

T&R A/c IOC/GAILFDs/Investments

Liquidity A/c

Investors

Operator

RILs A/c

Pledge

Interest

Income

Shortfall

Undertaking to

pay capex/opex

Supply of

Oil & Gas

Debt

Service

Sale of

receivables

Receivables

OverflowOpex/capex (in

the event of

default by RIL)

Topping up

of shortfall

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Pipeline Financing Structure

Refinery

Pipeline

Company

Off-TakerFIs & Banks

StrategicInvestor

EPCContractor

PipelineSponsor

Productpurchase

Equity

Equity

contract

Use of pay

contract

Joint VentureAgreement

Equity

Loans

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Project Risks

Risks

1. Project CompletionRisk

Impact:Cost / time overrun increases interest during construction, lossof revenues, and penalties to input supplier / off taker. Project

becomes non-viable. The largest items of project cost are the EPC

(Equipment) and Finance charges. The lenders are most

vulnerable if overrun occurs.

Mitigation:

1. Ensuring the promoter is resourceful / experienced in the relevant

field / ability to raise equity. The project size should be in line

with his resources.

2. Selecting an experienced and financially resourceful EPC

contractor.

3. Ensuring that the financial tie up is complete.

4. Confirmation that the project has obtained all regulatory

approvals.5. Appointment and review of the project by a lenders engineer.

6. Having LSTK / EPC type of contracts (i.e.) Fixed Price Contracts,

with performance bonds and liquidated damages.

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7. Tying up infrastructure; Grid connection for power

evacuation, road connection to ports, receiving

terminals for pipelines; Relocation

8. Ensuring completion of land acquisition / Right of

way for pipeline

9. Having sufficient contingent debt and equity in

escrew account

10. Equity stake from contractor

11. Sponsor supportcompletion guarantee / limited

overrun finance guarantee. The guarantee can beupto a date, has a ceiling amount or stops attaining

satisfactory D/E or DSCR ratios.

12. Predisbursement conditions

Promotors contribution to be brought upfront

Finance tie up

Government clearances

13. Undertakings

- Contingent equity in escrew account

- Completion guarantee

- Standby credit guarantee

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13. Adequate contingency provision in the project cost

Unforeseen

Items likely to have been left out

Items where full data is not available Price escalation

14. Loss of profit insurance

15. Arms length contractual agreement with promotors. If

sponsors have contractual relations their payments are

subordinated to lenders dues (input supply)

16. Sponsors guarantee for interest payment, dividendplough back and cash shortfall.

17. Delay in start up insurance

18. Strong concession / Government support agreement in the

infrastructure projects

19. Comfort letters stating

Awareness / consent Policy

Practice

Recognisation of liability / compliance

Cases: Synthetics and Chemicals, Rama Newsprint,

Essar Oil, Spic Petro, Nagarjuna Oil

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Risks

2. Market Risks Quantity Risk; lower demand/larger supply leading to

lower capacity utilisation

Price risk; lower product prices affect profitability

Causes of Market Risk:

a) Low width of the customer base and options for customers

(ExplosivesCoal; Electrical EquipmentStateElectricity Board) and customer dedicated pipelines

b) Entry barriers (RefineriesDistribution of products)

c) Inadequate promotion of new products

d) Lack of understanding of the user environment

(Polyester fibre, Potato chips)e) Competing facilities/nature of the competitors(Bombay-

Pune Highway) (Reliance Polyester, GrasimViscose

Fibre, EsselCollapsible Tubes)

Project Risks

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Risks

2. Market Risks f) Low value addition

g) Narrow product range/ single product

h) Poor financial position of product offtakers

i) Substitutes (Polymers)

j) Sponsor/company entering a field where their

qualities and success requirements do not matchk) By product disposalEnvironmental issues

l) Lack of application development for new products

m) Unwillingness to pay for services in the infrastructure

projects

n) Too localised market (housing, retail)

o) In case of Ports, tollways, lack of access roads

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Risks

2. Market Risks Mitigation:a) The only dependable mitigation for market risk is to ensure

international competitivenessInterfirm comparisonLeaders (low cost producers, brand leaders) never lose. Tisco,

Nalco, Hindalco, Hero Honda, Bajaj Auto, Grasim

b) A detailed study of the above issues and profitability of the units

operating in the industry

c) Higher value addition

d) Strong binding contracts for offtake and price

e) Equity stake from offtaker/input supplier (cost structure will be

known to them a risk)

f) Study of financials of the offtakerletter of credit and escrew

mechanism.

g) Cycle analysis

h) Special studiesTraffic studiesToll road, Jipp curve

Telecom (GNP -vs- Access lines / 100 people)

i) Viability funding by Government in infrastructure projects

Airbus/Boeing, Euro tunnel, Polyester, Noida Toll Bridge, Bandra-Worli Link, Airports.

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Risks

2. Market Risks Contracts:

a) Take or Pay agreements(Power) Commitment to offtake products of quantity within a

band

With banking

b) Throughput agreements(pipelines)

c) Minimum quantity offtake per month (LNG, Gas) No banking

d) Market preference contract

Sponsor/company to sell the specified product first

Offtaker gives preference to the company when

everything is samee) Requirement contract (cogeneration)

Compulsory delivery and purchase (no banking)

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Risks


f) Tolling contracts (Power)

Offtaker supplies inputs and conversion charges and

offtakes output

g) Advanced sales contract (Oil production)

Procurement of advances against future sales Securitisation of future sales proceeds.

h) Production payments

Escrewing a part of the sale proceeds for debt service

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Risks


i) Power Purchase Agreement (special case of take orpay agreement)

Capacity charge Rs./MVA/Month

Energy charges Rs./Kwh

Operation and Maintenance charges

Return on networth (Minimum = Debt service + return)

j) Buy back contracts (Minerals)

Sponsor to buyback the product if unsold

k) Long term sales agreementquantity of offtake

guaranteed but not price

l) Shadow toll agreement

In all these contracts, quality of the offtaker / counter

party is important. It needs to have escrew account

and waterfall mechanisms

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Contract Price Structures

Escalation based on index (consumer price index)

Cost based cost pass-through (Fertilizer, Power)(Opex +

Debt Service + Return)

Publically available prices Benchmarked prices (LNG to crude)

Comparison of alternative options (pipelines to rail, road,

shipping)

Floor, Cap, Collar systems of prices Cashflow based prices (sponsor is the offtaker)

Fixed prices (decline in real prices)

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Contract Price Structures

Fixed price plus a partial linking to indices ($75 plus53% CPI escalation or 70% GNP growth)

Put/call options

Linking product price/tariff to debt service

a) CPI based interest and tariff (Bonds)

b) Commodity loans

Equity stake by offtaker/Input supplier (cost structure

will be known to them - a risk)

Cycle analysis

Contract for differences: offtaker agrees for a fixed price

and swaps into a spot price

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Price and demand information

Chemsystems - Petrochemicals Ferticon - Fertilisers

Steel world - Steel

Petroleum refiner - Crude oil / petroleum products

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Risks

4. Promotors

Risk

Impact:Improper implementation leading to cost and time overrun.

Mitigation:

1. A detailed study of

compatibility of the promotor with the project (cultural fit)

Relevance of the past experience of the promoter

Relationship of promotor and the project (Is he a contractor

Euro tunnel)

Resources available with the promoter vis a vis the projects

size and its requirement of funds

In case of joint ventures, does the joint venture agreement

sets out obligations/rights of the partners and the role of

lenders in case there are disputes. Prohibition of amendingthe JV agreement without lenders permission

Provision for contingent equity /debt through bank

guarantees

Ability to implement and operate large projects

Ability to raise equity / debt

Project Risks

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2. Analysis of past results of companies

associated with promotor to study

His financial policies Quality of accounting

Approach towards financial risk (conservative/

aggressive)

3. Provision in the joint venture for dispute

resolution through buy/sell and lendersintervention

4. Reference to bankers, customers and suppliers

5. Concurrent auditors for monitoring use of

funds where reports are not conclusive.

6. Ascertaining sources of promotors

contribution

7. Pledge of shares

8. Ascertain details of other projects of promotors

9. Deferment of promotors dues / clawback

Project Risks

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9. Comfort letters from sponsors

Maintenance of ownership

Keep the company in sound financial position

Providing management support

10. Ensure promotors also earn adequately.Otherwise they will earn through purchases /

sales

Project Risks

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Project Risks

% inflation

Revenues 100 100 100Expenditure 60 60 60

40 40 40

Repayment 10 10 10

Interest 5 4 3

Net Cash flow 25 26 27

a) Inflation Risk:

5. Financial Risks:

Normally inflation benefits the company / projects if fixed rate loansare taken unless the product is subject to price control as petroleum

products, drugs and utilities

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Project Risks

10% inflationRevenues 100 110 121

Expenditure 60 66 73

40 44 48

Repayment 10 10 10

Interest 5 4 3

Net Cash flow 25 30 35

But if debt servicing is in a currency different from revenues, problem

could occur as rapid inflation and devaluation normally go together

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b) Interest Rate Risk: Increase in cost of project;

Volatility in interest leading to loss of viability

Mitigation:

(a) Interest rate swaps: Project company which has

an obligation to pay interest at a floating rate

agrees to pay the Swap Provider (Bank) thedifference between the floating rate and the

preagreed upon fixed rate. If floating rate is

lower, company will pay Swap Provider (SP) and

SP will pay company if it is otherwise

(b) Consumer price index based interest

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Principal 100 100 100

Prime Lending Rate (PLR) 8 9 10

Swap Fixed Rate 10.5 10.5 10.5

PLR Interest at PLR + 2% 10 11 12

InterestFixed Rate 10.5 10.5 10.5

Floating Rate 10 11 12Difference (0.5) 0.5 1.5

Receivable / (Payable to Swap

provider)

(0.5) 0.5 1.5

Thus the project company has turned its floating interest

loan to fixed interest at 10.5% per annum

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Features of Swap

a) Average swap rate is a weighted average rate for a seriesof swaps covering each repayment. Hence varyingprincipal amounts are taken into account

b) Basis of fixed rateGovernment bond rates for therelevant period

c) Swap market premiums reflect supply and demand in theswap market / fixed rate corporate bond market

d) Credit risk of the company =credit margins X % of principal at risk

e) The swap agreement is usually between the company and

one of the consortium lending bankers called frontingbank as otherwise swap roll over in case of delay indraw/repayment creates problem

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Features of Swap

f) The fronting bank enters into back to back arrangementswith other swap providers if so desired by company

g) Syndicate of lenders counter-guarantee fronting bank.

Swap Breakage due to default and swap breakage cost


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Swap Breakage due to default and swap breakage cost

Default in second year by which time fixed rate declines from 10.5% to

9.5%. Bankers enter into a new swap at fixed interest of 9.5%

Principal 100 100 100

Prime Lending Rate (PLR) 8 9 10

Swap Fixed Rate - Original 10.5 10.5 10.5

Swap Fixed RateRevised 10.5 9.5 9.5

Floating Rate 10 11 12

Interest (Amount)

- Fixed Rate (original) 10.5 10.5 10.5

- Fixed Rate (revised) 10.5 9.5 9.5

- Floating Rate 10 11 12

Difference +ve or (-ve) for swap- Original 0.5 (0.5) (1.5)

- Revised 0.5 (1.5) (2.5)

NPV of loss (at 10.5% discount) - 3.8

Thus the swap provider looses due to swap breaking if fixed interest goes down.

This is called breakage cost which is 3.8%

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Fixed Interest rate

No interest rate risk but to avoid duration

mismatch on long term loans, bankers usually

provide only floating rare loans.

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c) Exchange Rate Risk: Gap in financial plan. Mismatchbetween revenues and expenses leading to loss of viability(1) Implications if the financing and outlay are in different currencies.

- Change in project cost leading to financing gapFinancing Expenditure Rate Rs./$

Original $100/Rs.4300 4300 43

Revised $100/4100 4300 41

Gap 200

- Change in debt repayment capacity if revenues andfinancing are in different currencies. Variation in the

quantum of debt relative to cash flow

(2) Mismatch due to revenues, operating costs and debt being indifferent currencies.

Loans

Sale Proceeds

Equipment cost

Repayment/interest

Input cost

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Mitigation:

Use of hedging of principal through currency swaps possible but it isdifficult for long term project loans due to credit risk. Breaking of swaps

is costly To protect against project cost increase, as far as possible, the currency of

equipment purchase (EPC) and financing currency kept same. Risk passedonto EPC contractor

To protect against exchange risk in operations, effort to be made to makethe debt servicing equivalent to net foreign exchange earning

Indigenization of components (Auto) Offshore account subject to RBI regulation

Exchange risk on debt servicing passed on to offtaker provided he iscapable of taking it.

Normally the risk of devaluation is counteracted by inflation benefits. Buttiming is the key and some temporary protection is required.

Natural hedge : toll road financing in local currency: oil production through dollar financing

Pass through tariffs for both capacity and operating charges; check localaffordability

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Risks

d. Funds shortage for projectcompletion/ servicing loan

in the initial years

(Financial Risk)

a) Provide for cash loss in the initial years in theproject cost itselfcomparison with similar

projects

b) In case of high business risks, reduce

leverage.

c) Provide for contingent debt/equity.

d) Ascertaining details of funds requirement of

other ongoing projects of promotors

e) 100% tying of funds including promotors

contribution before disbursement

f) Repayment matching cash flows (ballooning

schedules)

Project Risks

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Risks

6. Technology Risk Low capacity utilisation and higher consumption of inputs

leading to the lack of viability. It is important in sectorslike telecom. Quality in mineral projects and short

effective life in software.

a) Ensure a strong project implementation team

b) Involve the lenders Engineer in the project right from

the initial stage

c) Involvement of a local engineering company from the

initial stage

d) Spelling out a detailed vendor development programme.

e) Analysis of experience of other companies which haveutilised a similar technology

f) Application Development

g) Strong contracts with warranties

h) Payment in terms of royalty rather than downpayment

Project Risks

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Risks

6. Technology Risk i) Lenders engineer to report on competence of EPCcontractor / technology supplier

j) Size of EPC contractor vis--vis the proposed project (max

10%)

k) Credit worthiness of EPC contractor

l) Report of lenders engineer on provenness, obsolescence of

technology, competitiveness of other technologies

m) Experienced O&M operator

n) Equity investment by technology supplierEPC contractor

o) Business interruption insurance

p) High performance bonds, penalties for non performance/

buyout structures

q) A study on the history of technology and time taken for

stabilisation in that industryindicates life of technology

r) For infrastructure projects, strong operation and

maintenance agreement with maintenance bonds.

Project Risks

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Technology Risk

Technology from individuals

Unproven Technology

Changes in Technology

Liquidation of collaborator

Unsuitable raw materials

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Risks

7. Operating risk i) Cost risk- Increasing consumption of inputs enhances cost of

production and affects viability

- The only reliable mitigation is ensuring international

competitiveness. Leaders never fail (TISCO, Reliance,

Grasim) as prices fluctuate

- Effective contractsa) Cost pass through

b) Escalation based offtake contracts

c) Cost guarantee (consumption of inputs, and

operation and maintenance)

d) Subordination of costs like royalty and input costs if

supplied by promotors. The amount payable tosponsors for land etc. is deferred till positive cash

flow.

Project Risks

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Risks

7. Operating risk e) Analysis of cost curve. A company with low operating costand higher fixed cost is viable with elongated repayment

schedule. Cost curve is production quantity versus cost of

production

- Cash flow controls

- Assignment of contracts

- DSRA / liquidity A/C

- Pledge of shares

- Default triggers

Project Risks

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Risks

7. Operating risk ii) Management riskConstruction: Driver, time/budget and critical path experience

Operations: Relationship, hands on management, flexible,

focussed and mature person

Project Risks

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Risks8. Non-availability of

critical inputs and

price volatility

Higher cost of raw materials/other inputs leading to viability issues.

Each industry has certain critical input factors. Power-fuel; oilexplorationreserves of oil and also production decline over

years. Water supplywater, miningreserves

Mitigation:

a) Widening the range of suppliers

b) Arresting price volatility through long term supply agreementsc) Integrate manufacture of critical components in the manufacture /

Indigenisation of components (auto)

d) Ascertain the relationship of the prices of input and product

e) Entering into a Put or Pay agreementthe input supplier agrees to

supply the fixed quantity of input or pay an amount equal to cash

value of extra cost incurred in purchasing the input over thecontracted cost. These contracts are to be assigned to lenders.

f) Indexed prices

Project Risks

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Risks

8. Non-availability of

critical inputs and

price volatility

g) If promotors are contractors for offtake / input supply

subordination of payment

h) Pass through to off taker (Power, Fertilizers)

i) Hedging

j) Detailed study of reserve risk in oil / minerals / coal

including access to alternate reserves

Finance only proven reserves

Leave a tail of 25% which is difficult or costlierNPV tail

to extract.

k) Special studies on wind for wind farm and water supply for

hydroelectric project

l) Assessing credit worthiness of the supplier, experience,ability

m) Building up adequate storage arrangements for inputs at site

n) Monitoring supply arrangements such as rail, road etc.

Project Risks

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Risks

8. Non-availability of

critical inputs and

price volatility

o) Many a time, input suppliers are required to provide

collateral/contingent equity as a back up of contract

p) The cost of production of the input supplier is also critical.

A provision to purchase from alternate sources upto a

certain quantity in case it is cheaper is desirable.

q) Banking provisions in the contract

r) Tolling contracts) Special studies through experts

i) Oil production reserve estimation; production rates and

profile; production costs; oil quality and associated gas over

years;

ii) Miningquality of product

iii) Cost curve analysis (cost versus production) for fuel inputs

iv) Variable productionlink repayment to production $3 /

barrel.

Project Risks

Example: LNG Contracts, fuel supply agreements, Ancillary

supply contract

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Risks

9. Regulatory Risk Increased cost, stoppage of production, control on salesprice, change in tax / environment laws / informal

price ceiling (petro products), revocation of

concession agreements

a) Study of price control policy (drugs, sugar) to

understand implicationb) Avoid heavily subsided operations (naphtha based

fertliser/power units)

c) Credit policy in case of agriculture dependent

industries

d) Understanding the state government policies withrespect of labour/closing unviable operations

e) Ensuring that the unit is internationally competitive

so that it can resort to exports in case of problems.

Project Risks

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Risks

9. Regulatory Risk f) Understanding local government willingness to reformg) Ensuring that creditors rights are enforceable in a

court of law

h) Involving multilateral agencies in the consortium

i) Ensuring availability of land / right of way

j) Exchange controls for foreign currency loans,maintenance of foreign accounts and holding foreign

currencies.

k) Investment permits by foreigners and dividend

repatriation

l) Import of inputs / export of outputs

m) Construction / operation permits

n) Work permits for foreigners

Project Risks

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Risks

9. Regulatory Risk o) Provision of infrastructure

p) Provision of tax concessions

q) Exclusivity (airport / road)

r) Strong concession agreement for infrastructure

projects

s) Completion guarantee of sponsors

In large infrastructure projects, it is better to have a

Government Support Agreement with the State

Governments / Central Governments on these issues.

t) Emissions / water pollutionu) Catastrophe (Bhopal, Chernobyl)

v) Lawsuits, agitations, blackmail

Project Risks

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Risks

10. Environment

and social risk

a) Lenders engineer to give a report on environmental complianceincluding decontamination costs, transportation of toxic

materials, regulatory, permit and licensing issues

b) The risk to be partly passed to EPC contractor

c) Through Environment impact assessment study

d) Resettlement and Rehabilitation Plan and plan monitoringe) Public Consultation / compensation / information

f) A sound environment Management Plan

g) Involving multilateral agencies in financing

h) Government support under concession agreement

i) Study of adequacy of local standards.j) Study of world bank handbook (guidelines)

Project Risks

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Risks

10. Environmentand social risk

k) Appointment of an experienced operation & maintenancecontractor (NGO liaison and Government management)

l) Plan for emergency response

m) Reprocessing of waste (fly ash, slag cements)

n) Trading in environmental creditspurchase a heavy

polluter in the zone and shut it down / or clean up to

keep/reduce pollution levels in the zone (sulphur,

greenhouse gas)

o) Second hand plants

p) Infrastructure O&M agreements to have environment

warranties

q) Legal opinion on whether all environmental clearances

have been obtained

Project Risks

1. Hydropower projects

2. CFCS

3. SIV

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Risks

11. Infrastructure risks(Availability of

power, water,

communication and

transportation)

Delays in completion of the project and results in overrunMitigation

a) Monitoring of the arrangements of the offtaker for

lifting of products such as grid connection for power,

terminals for pipeline

b) Access routes for pots and airports

c) Railway siding for coal / inputs etc.

d) Effluent disposal

e) Drainage

f) Right of way for pipelines, road projects

g) Centralised facilities

h) Transportation (examplescrude in Rajasthan)i) Strong concession agreement / Government support

agreement in infrastructure projects

Project Risks

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Risks

12. Legal / DocumentationRisks

Legal council to check:a) Whether date of commencement is same in all

documents (EPC, Loan agreement, offtake

agreement)

b) Matching of dates of input supply and offtake

agreementsc) Whether penalties payable to offtaker for poor

performance is fully passed on to offtaker

d) Input (fuel) price formula in final supply

agreement and offtake agreement

e) Force majeure definitionf) Date of completion / loan payments

g) Legal procedures for taking and enforcement of

security / contracts

h) Obtaining / renewal of permits / licenses

Project Risks

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Project Risks13) Political risk

Currency inconvertibility Expropriation

War and insurrection

Termination

Environmental laws

Landowners activities

NGO action Legal / bureaucratic approach

The country unwilling or not able to service loan due to political, social and

economic factors in cross border lending

Cancellation of concessions, licences, permits, tariffs, quotas, price control

Mitigation

Involve multilateral agencies in funding Insurance from Exims

Assurance from Central Bank regarding availability of hard currency

Review of the legal and regulatory regime

Insurable

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Project Risks14) Counter party risk

Strength / reliability of offtakers / swap providers,contractors, lenders, insurers

Mitigation

Check the financial strength and past experience

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Risk systemsa) Project completion risk

b) Market risks

c) Inflation risk

d) Interest rate risk

e) Exchange rate risk

f) Funds shortage for completion of project risk

g) Technology riskh) Operating cost risk

i) Operating management risk

j) Supply of input risk

k) Regulatory risk

l) Environment and social risk

m) Infrastructure risk

n) Legal / documentation risk

o) Force majeure risk

Financial Risks

Operating Risks

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Profitability

Item Risk systems

A. Output (Quantity) b, l, o, j

B. Price of product b, e

C. Revenue A x B

D. Less: Cash costs e, g, h, i, j, l, mOverhead c, k, n

E. Net operating cash flow CD

F. Interest e, d

G. Income tax k, o

H. Net cash profit (EFG)

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Cash flow / Balance sheet items

I. Equity a, f

J. Project loan a, c, d, e

K. Working capital b, h

L. Capex a, c, e, f, g, d

M. Principal repayments e, o

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Power a) Poor financial position of offtakerElectricity Board

b) Fuel cost and heat rate; Degradation of heat rate overtimec) Lack of reforms

d) Base load, peak load

e) Availability of natural gas

Toll roads a) Traffic risk (diversion %), traffic mix

b) Risk due to linkage with real estate (Bangalore/Mysore highway,

Mahankali flyover)

Resources (Oil, gas, mining)

Estimation of reserves / decline over years

Price risk

Rehabilitation / social risk

Telecommunication a) Foreign exchange risk

b) Regulation (ownership, services, tariff)

c) Market risk / customer retention

d) Technology obsolence risk

Sector Specific Risks

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Ports / Airports /

Stadium

- Concession conditions

- Market risk (competition from existing)

- Infrastructure (Access risk)

- Concession income risk

Water - Regulatory risk on user charges

- Cost of water procurement

- Seasonality

Refineries - Marketing outlets (Entry barriers)

- Access to pipelines

- Exchange rate risk

Chemicals - Environmental risk

- Technology risk

- By product disposal

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Steel - Price risk

- Availability of high quality raw material

Cement - Local demand risk

- Availability of limestone

Pipelines - Confirmed usage, tariff

- Right of way

General - Take the experience of last 10 similar projects; If you

havent done a similar, what is special about this project

- How this application travelled from sponsor to your desk

- Is this the first project of sponsor

- Look at management and cash flow

Project and Infrastructure Finance Slides Module2_Ver3

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