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Finance
Financing Large Scale Projects
Corporate Finance V/S Project Finance
Equity Debt
Company
Corporate Finance V/S Project Finance
Then how is it
possible for
projects
Take to raise
allcapacity,
major
Plant
such
decisions
Active large
Sponsors debt?
Investors
related to Passive Investors
Technology, Fuel,
the projectetc.
Equipment
Comprehensive
Corporate Finance Project Finance
• Which is more risky or uncertain: financing
Debt
Generally,
Would
Contractual Agreements
Generally
project
it have
this1/3
loans
been
debtare
better
is non
cashifrecourse
flow
lenders 2/3limited
based
had
or and
access
notrecourse
to
asset
assets?
backed.
corporations or financing projects?
Equity 2/3 1/3
Historical Annual Project Finance
Default Rates 2001-10
Who should go for Project Finance
1. Capital investment projects that are capable
of functioning as independent economic units
2. Can be completed without undue uncertainty
3. When completed will be worth more than the
cost to complete
Project CFs go to project
Projects have finite life
lenders and sponsors
Which project specific characteristics
should be considered
1. Credit requirements of lenders- profitability of the
project and indirect credit facility that would be
provided (viz. by suppliers)
2. How is the project tax shield being shared between
capital providers
3. Impact of project on the agreements governing the
sponsor’s existing debt obligation
4. Regulatory requirements that the project must satisfy
Decommissioning or environmental restoration
5. Accounting treatment
liabilities.of project
So the liabilities
BV of the asset and
cost may also
include the decommissioning cost for purpose of
contractual agreements depreciation
Why Project Finance
• Traditional School of thought: Shah and Thakor (1987) very large, high
risk projects.
• Chen, Kensinger and Martin (1989) PF is used even in medium size
low risk projects such as cogeneration facilities.
• Chemmanur and John (1996) explain the need for PF on the basis of
its benefits of corporate control
Desire for control
How Project Finance Creates Value?
Low High
Comparable
ReducingCapabilities
Agency Costs
Debt to equity
What if someone wants to
Land
Government Project Company
Shareholders
SponsorexitAgreement
License Concession period (SPV)
Determines
Who getshow
to sit
a company
on the
will be ownedboard
and managed
Can a investor be fired
Dividends
Development
Viability Construction Operation
Clearances
What is financial Closure?
Financial Closure and Contractual agreement? (EPC,
Where is most of thepower purchase,
investment fuelhappening???
CAPEX supply etc.)
Sponsor
D=4000
E=1000
V=5000
There is a positive NPV project with a value of 1700 after investing 1000. Will Debt holders
provide capital?
Boom Recession Expected
Value 6700 4100 5400
Debt 4000 Why does this happen?
4000 4000
Equity 2700 100 1400
Highest but
additional
services such High to
medium
as dem esti, medium
viability etc.
Sources of Capital-2 International
Credit Markets
• Cheaper capital from investors used to long term
investments. But due to unfamiliarity with doing
business in the economy would like:
– ToVendor
establish economic
Credit (Vendor has better viability beyond
understanding doubt
of the project
But Vendor is not a banker so refinance)
– Protection against competition
– Borrower/Sponsor’s track record
EXIM Bank of the Equipment Supplier country
– Attractiveness of currency, Inflation
– Political, Economic and Policy Stability
Multilateral Donor Agencies (WB, IFC, ADB, AfDB)
Loan
Syndication
Equity Debt Market
Not
Consortium
Lending
Company
Financing Choice: Equity vs. Debt
• Reasons for high debt:
Remaining Rs.
1336 crore should
Agency Francaise de be raised by SG
Development (AFD) and CG Canara
throughBank
Rs. 1170 crore
subordinate loan @ 10.8%
debt
Rs. 1,525 crore loand at KMRL (Rs. 5537 for 20 years with a
2% for 25 years with a Crore) moratorium of seven years
moratorium of five years
SG and CGSponsor
Rs. 753 crore each
Contractual Systems in
developing Petroleum Assets
Three Dominant Systems
1. Concession/Licensing Agreements
2. Joint Venture Agreements
3. Production Sharing Agreements
Concession or Licensing Agreement
Concession or License Agreement
• Government gives concession to a operator (exclusive
rights) to Explore, Develop, Sell and Export Oil or other
minerals from a specific area for a defined period.
• Advantage:
– Concessions are less complicated as compared to a JV or PSA
– It is best for home government because the entire financial
risk is borne by the bidder.
• However there are two issues
– Loss of time in bidding
– May not attract the best bidder who is financially strong and
technically competent.
• Disadvantage
– No knowledge of potential (of the reserve) in other words
incomplete information can hurt either party... But never
both
Questions to Government
• Were tender terms made public?
• Length of the Concession
• How many people bid
• What has the successful bidder agreed to pay
• Who was the external advisor
• How long is the work program and how much will
the bidder invest
• What is the revenue share agreement between the
Central Government and the Local Government
Questions to Companies
How much will be paid for the concession and to
whom?
Criteria for choosing the local sub contractor
Joint Venture Agreement
Joint Venture
National Oil
Companies Pure JV: All Costs/Risks Shared
Complexity of PSA
• If PSA is enacted into a law, then it provides security to pvt oil cos.
As a result, gov, surrenders its right to adopt new laws and
regulations in public interest if it adversely affects their interest.
• Conversely, leaving the PSA flexible is not the greatest for the local
government because it lays stress on having access to technical,
financial, commercial and legal expertise.
Questions about PSA
• Was there a competitive bid
• What types of payments will the government
receive? (Bonus etc.)
• What other payments will the companies make?
• Are companies obliged to invest in local
communities (hospital, school etc.)?
– Will the govt. Give tax concessions?
– Is the commitment to be deducted from taxes or open a
credit line against tax obligation?
• How is the profit going to be shared?
• How is the cost of environmental damage to be
treated?
Regulatory Pricing Mechanism: Regulation
•Regulation of public utilities has traditionally been
justified on ground of public interest and natural
monopoly characteristics(Priest, 1993)
•Types of regulation
•Private
•Voluntary
•Public
•Dominant form of regulation is public (Blundell and
Robinson, 1999)
•Some view regulation as a temporary phenomenon till
effective deregulation involving competing private firms
are introduced.
Incentive based regulation as a dominant
alternative to RoR or Cost of Service Regulation
• Main obj of incentive regulate is to promote efficiency
improvement by rewarding good performance relative to some pre
defined benchmark.
• Approaches to incentive based regulation
– Rate of Return Regulation
– Price Cap Regulation
– Cap on Total Revenue
– Cap on Average Revenue
– Combination of the two
– Weighted Avg Price Cap
– Earning Share Regulation
• As a first step Benchmarking
• Comparison of Actual performance against a reference or
benchmark performance
Rate of Return Regulation
An estimate of cost (opex, capex, tax, dep) and
demand associated with a recent historic ‘test’ year
for providing a set of services in that year
Steps:
Set of products or services to be supplied is
determined
Given the volumes the expected aggregate cost of
supply is estimated and a consultatively agreed
upon fair rate of return is added.
Find the per unit service price
Dis/advantages of RoR
• Close alignment between price and cost
• Safer for the contractor and hence easy to attract
investors.
Some of the ways in which the industry has addressed these
issues are by:
(i) Value of the RAB is determined on basis of efficiency costs
• Issues
(ii)Extending the length of the control period
–(iii)Disallowing operating
If Regulator has limitedcosts which areabout
information assessed to be
the supplier’s
inefficient
costs or
– Unable to confidently audit the operators actually costs
– Known problem of Gold Plating
RoR
• RoR is best suited to regulated sectors where limited cost
or productivity efficiency gains are possible
• Additionally eco setting where the regulator is able to
obtain sufficiently accurate and detailed information about
costs and future consumer demand, RoR, in principle
allows the regulator to set efficient tariffs.
• However, RoR would not work where:
– (i) Existing suppliers (benchmarks) are not fully efficient
– (ii) where the industry is ‘dynamic’ viz. Rapid demand or
technological change
PCR
• Maximum allowable average price (revenue) path
for a set of relevant services for a specified period
– This price path is independent of the ‘actual cost’ of
providing this service.
– 1+RPI-X
Average price is set so as to be independent of the
controllable costs of the supplier for a significant
period of time
Types of PCR
• Cap on total Revenue: Revenue earned is constant
and is independent of the fluctuations in the
quantity supplied.
– Who bears the risk of demand volatility? Consumers
– When demand is falling prices will ______________?
rise
• Operator has a perverse incentive to:
– Reduce volume of sale
– Degrade quality of services
– To Reduce consumption supplier may set prices above
marginal cost on the most elastic services
Types of PCR
• Cap on Average Revenue: Allowable average revenue
per each unit of output is capped.
Note: Actual revenue earned on each unit is not capped
– Who bears the risk of demand volatility? Supplier
• If dem lower than expected? Part of FC not recovered
• If dem is higher than expected? Higher Profits
• Supplier therefore has incentive to expand demand beyond
what is forecast.
• Increase the quality of service offered to high demand
customers
• Price the service to encourage greater usage by high
demand customers.
X-Factor for the first control period
in IGIA Delhi
Types of Benchmarking
• Frontier Based Benchmarking
• Mean and Average Benchmarking
• International Benchmarking
Frontier based benchmarking
• Estimate the efficient performance frontier from
best practices in the industry from within a
sample of firms.
Efficient frontier is the benchmark against which
the performance of individual firms is measured
– Frontier Based Benchmarking-Data Envelopment
Analysis (DEA)
– Mean and Average benchmarking - Corrected
Ordinary Least Square (COLS)
– Stochastic Frontier Analysis (SFA)
Data Envelopment Analysis
• DEA does not require specification of production or
cost function
• Allows calculation of allocative and technical
efficiency
• Technical efficienyc can further be decomposed into
scale, and pure technical efficiencies.
• Can be used in conjunction with Malmquist indices
Efficiency Benchmarking using DEA- Input
Variables - Genco
• Opex (Rs/Unit)
• Number of Full time employees
• Hydro power capacity (% and MW)
• Thermal power capacity (% and MW)
Corrected OLS
• Instead of looking at frontier functions this method
estimates effieicenty measures based on mean or
average performance (production or cost function).
• The actual peformance of the firm can be compared
to the estimated pefromance by plugging their
inpur output and evniromental data into the
estimated (coefficients) function.
Aim of Power Sector Reforms
To Achieve allocative and internal efficiency through
competition, privatization and price mechanism
(Vicekrs and Yarrow, 1988)
What are the possible reforms?
• Introduction of competition in generation
• Design of Organised power markets
• Unbundling of Generation, transmission,
distribution and supply (retail)
• Ownership reforms or privatization of existing
assets
What are the reforms generally taking
place
• First acceptance of price mechanism
• Competition in generation and supply
• T&D generally kept as natural monopoly
Geographic Distribution of
Project Finance
Sector wise distribution of PF
PF by source of funding
Top deals in EMEA
Top Deals in Americas
Top Deals in Asia and Pacific
Top Deals in Europe
Break up of use of PF in Social
Infrastructure
Conventional V/S Renewable
energy by value
Global players in PF
Global Book Runners