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BP Amoco (A) : Policy statement on the use

of Project Finance
Manish ( 014epgp2014 )
Bhupinder Singh ( 007epgp2014)

Content

Organization structure
Post Merger Structure
Assignments
Project Finance vis--vis Corporate finance
Advantages
Disadvantages
Structure
Sources
Institutions

BP Amocos PF vs CF Model

Organization Structure
British Petroleum

Amoco Corporation

UK based worlds 3rd largest Oil &


Gas giant

US based worlds 6rd largest Oil &


Gas giant

Operations in 70 countries

Operations in 25 countries

56,000 employees

43,000 employees

CEO Sir John Browne

CEO H Lawrence Fuller

Assets $ 54.6 bn.

Assets $ 32.5 bn.

Revenues $ 71.3 bn.

Revenues $ 31.9 bn.

spite
Profits
Profitsof
$ 4.1
bn. (1997)
$ 2.7 Corp.,
bn. (1997)
In
corporate
rivalry between BP
& Amoco
both merged in
1998 to form BP Amoco to create financial synergies required to fund
capital intensive projects.

Why Merge ?
What prompted the merger of the two arc rivals?
Belief that success in capital intensive Oil and Gas Industry was
becoming increasingly dependent on scale.
Scale and Synergies
See Case page 3.
The best investment opportunities, in terms of rates of return on capital
employed, will be ones that, because of location and complexity, will be
available only to companies with greatest financial resources.
The risks are high and capital cost enormous as are the potential
riches if a huge oil field is discovered. Only well capitalized firms big
enough to afford the time, money and risk required to play poker game
can hope to thrive.

Post Merger Organization Structure


(Exhibit 4)
Global HQ in London with Sir John Browne (BP) as CEO
H Lawrence Fuller (Amoco) & Peter Sutherland (BP) as non
exe co-chairman
Finance Group:
CFO: John Buchanan (BP)

Treasurer: David Watson (BP)

Head Specialized Finance: Bill Young (Amoco)


Both companies had highly centralized finance functions with
preference for corporate financing over project financing.

Assignment
Goal:
To work out new financing policy for the merged entity.

Process:
Watson & Bill sought opinion of finance executives of both the firms
regarding their take on project finance vis-a-vis corporate finance.
BP sparingly used project finance
Amoco too, believed in corporate finance more. But they sometimes
used project finance.

Issues
Finance Organization Structure
Project Finance Concepts
Cost and benefits of PF
Decision on Corporate Finance/Project Finance
Oil Industry economics
Type of Projects Basics (Development, Exploration,
Refining, Marketing, Power Plants)

What is Project Finance ?


Project Finance involves creation of a
legally independent entity financed with
non recourse debt for the purpose of
investing in a industrial asset, Usually
with a limited life.
Characteristics :

Future Cash Flows


Project Asset as collateral
Finite Life
Non recourse debt

Corporate Finance v/s Project Finance

Project Financing Vs Corporate


Financing
Corporate
Financing
Organisation

Control &
Monitoring

Risk Allocation

Corporate structure
-Large businesses

Project Financing
Corporate structure
Cash flows only from
Project assets

Cash flows from different


assets are mingled
Control vested in
management, Investors
role minimal

Stringent monitoring

Full recourse
Diversified across
assets

Limited/Non- recourse
Contractual arrangements
for risk distribution

Corporate
Financing
Criteria

[On Balance Sheet]

Financial

Easy/fast

Flexibility

Project Financing
[Off Balance Sheet]

Difficult and time


consuming, highly
structured

Free cash flow

Can be freely

Must follow cash waterfall

used. Commingled
and allocated as per
Debt Contracts

Debt capacity

Corporate Policy

Cash Flow Sweep

Lenders seek

Lenders recourse to all

recourse all assets

project assets

Typically unsecured

Secured

Seen in entirety

Only out of project assets


plus Credit support from other
sources

High leverage Possible

Corporate
Financing
Criteria

Bankruptcy

Transaction
Costs

Agency Cost

[On Balance Sheet]

Costly and time consuming


Financial distress can be
avoided
Beneficial to lenders as
they have access to entire
asset

Lower

Equity Investors exposed


Management Incentive
project
Specific is difficult

Agency Cost Greater

Project Financing
[Off Balance Sheet]

Cost of resolving financial


distress lower,
Bankruptcy remote,
more risky to lenders

Higher

Agency cost for FCF


reduced Incentive can be
tided to PF Closer
monitoring by investor
Under investment
mitigated Agency cost
lower

MARKET
IMPERFECTIONS

PROJECT FINANCE

Higher structuring cost to set up project


Transaction Cost
Project finance has higher
cost

Lower structuring Cost

company (lawyers, independent consultants,


financial advisors etc)
Easier to obtain operating synergy
Harder to obtain operating synergy as project may
be economically independent
Less threat of risk contamination (isolate

Distress Cost
Unclear advantage

CORPORATE FINANCE

Greater threat of risk contamination

losses at the project level)


Greater potential for co insurance
Little benefit from co coinsurance

Taxes
Project Finance has higher
taxes
Information Cost

Less ability to use interest tax shields and net


operating losses
Better information about project assets and
cash flows (more transparent)

Greater ability to use interest tax shield and


net operating loss
Less information on multiple, Co mingled
assets and cash flows

Greater disclosure can be costly from a


competitive perspective
Little managerial discretion (more discipline
can be value enhancing)
Restrictions on use of cash flows

Greater managerial discretion- depends if


discretion is beneficial
Greater risk of leverage induced under

Project Finance has higher


information cost

Agency cost
Unclear advantage

investment

Project Finance Model


Lenders

Sponsors

Contractor

Project
Finance
Debt

Equity

Finan
ce
Support
Agreement

SPV
Concessions

Supplie
r

Off
takers

Government

Corporate Finance Model


Funds

Operating Cash
Bus

Long term
finance
Short term
finance
Money Market
Inst.

BP
Amoco
Treasur
y
Subsidi
ary
share

25% Share

Partner
1

Company Finance
Structure:
Debt 30%
Equity 70%

Project

Cash from
Cash Back to source
source

35% Share

Partner
2
Liabilities

Project Finance Model ( BP


Subsidiary )
BP Amoco
Business
Units

BP
Amoco
Treasury

Company Finance
Structure:
Debt 30%
Equity 70%

Debt Service

Subsidiar
y
25% Share

Partner
1

40% share

Project

Collate
ral

Lenders
35% Share

Partner
2

Project Finance Model (used in


Projects)
BP Amoco
Business
Units

BP Amoco
Treasury

Company Finance
Structure:
Debt 30%
Equity 70%

35% Share

Subsidiar
y
25% Share

Debt

Lenders
Collateral
35% Share

Partner
1

40% share

Partner

Sponsors Equity

Project Finance vs Corporate Finance: Payoffs


(hypothetical)
Corporate Finance
Pay-offs

Project Finance
Pay-offs
Project Value

Put Premium
Debt
Debt Level

Walk away
Put
Option

Financial Comparison (1998)

Texac
o
Chevro
n
Mobil
BP
Amoco

Net Income
Revenues
Market Cap
Capex

Exxo
n Shell

Debt/Capital

20
%

40
%

60
%

80
%

100%

Exceptions for using Project Finance


Mega projects
Projects in Politically Volatile Area
Joint Ventures with Heterogeneous
Partners

Project Finance used as important risk management tool

Risk Sharing
Transfer of risk to other parties that can bear and risk more
cheaply and effectively
Large investment for several years requires partners

Risk Mitigation (Reduction)


Through Structuring and participation of Multilateral agency

What are the Cost and Benefits of Project


Finance ?
Costs
Higher fees and Interest
rates/Spreads
Increased time
Reduced Flexibility
Increased Information
Disclosure (Compromise
on Privacy/
Confidentiality)

Benefits
Sharing of Risk
Risk Management
Put Option (if walk away)
Expand Firms debt capacity
Interest Tax shield
Tax Holidays (if separate entity
required)
Better risk allocation with various
parties
Suitable for high risk, first time
investments, new industries etc.
Partners bring the needed know how