Chad-Cameroon Petroleum Development

and Pipeline Project

Background
Corporate finance vs. project finance
Why is there a difference between financing of field and export
systems?
The role of World Bank
Assessment of project risks and returns
Real options
Project update
Background
ExxonMobil, Chevron, and Petronas undertake a $4 Billion petroleum
development and pipeline project in Chad, which presented a unique
opportunity to stimulate Chads economic development, and yet
entailed environmental and social risks.
Corporate finance for the development of the field system and
project finance for the pipelines
Debate on unstable political structure and how Chad would use its
share of project revenues
WBs introduction of Revenue Management Plan to target Chad
Governments returns from the project for developmental purposes,
and debate on the likelihood of effectiveness of such a plan

Corporate financing for the field system:
The lead sponsor, ExxonMobil had AAA debt rating, very strong balance
sheet ($145M assets) and $16M cash flow Could afford the field
investment in a less costly way relative to project financing
ExxonMobil was actually a huge portfolio of upstream businesses
(exploration, development, production of crude oil and natural gas),
downstream businesses (transportation, marketing, and sales), as well
as chemical byproducts and operations in mining. With less than
perfect correlation among its assets, ExxonMobil might actually have
been able to eliminate the idiosyncratic risks via adding a field
development project to its portfolio. Corporate financing as opposed
to project financing helped ExxonMobil keep the project as part of its
portfolio and reduce the risks.
Besides, the vertically integrated business model made it a naturally
cost-efficient choice for ExxonMobil to hold the assets collectively
with corporate financing rather than individually with project
financing
Corporate financing probably also enabled managerial flexibility and
discretion over the use of oil wells, drilling equipment, etc. that
constitute the field system


Corporate financing for the field system:
Field development was the less risky part of the entire project for the
sponsors, because upstream operations including field development
and production was one of the core business areas where they were
very strong at. This reduced the cost of bearing these risks themselves
since they were better equipped than anyone else.
Project financing for a field development project would also not be a
viable financing option, as the lenders generally would be reluctant to
finance until after all reserves are proven and capable of production.
The crude oil prices for the last 18 months ranged from $9 to $42,
averaging $20 per barrel, which, even after discounted for the lower
grade, was considerably higher than the projects $5.20 exploration
and development costs. With a total proven plus probable reserves of
917M barrels, downside exposure to price and resource risk was
already mostly eliminated No serious need to protect from the
downside risk (via risk sharing )with project finance and incurring
higher interest rates and loan fees.
Corporate financing probably also helped save both the costly delays
at the development stage of the project and the structuring costs,
which would be incurred in project financing

Project financing for the export system:
Export system was the riskiest part of the project. Project financing
for the export system mainly enabled the sponsors to spread the
political risks as much as possible via the presence of outside lenders
such as WB, IFC, ECAs.
The expectation was that the Chad and Cameroon Govts would be
less likely to take or tolerate adverse actions against the project in
fear of jeopardizing future funding from the WB and other
international financing institutions who were lenders of last resort
Additionally, it facilitated alignment of Govts interests with the
project through equity ownership, which would not have been possible
otherwise as Govts could not afford on their own
Project financing also created the opportunity for the pipeline
companies (JV between Govts and the sponsors) to issue limited-
recourse debt, guaranteed by the sponsors through completion
Project financing enabled external monitoring from the lenders
ExxonMobil also reduced total investment commitment to the project
under the corporate/project finance structure, compared to that
under a complete corporate finance structure

The role of World Bank:
WB involvement assured sponsors the much needed protection against the
political risk
Besides direct investment through A loans, it mobilized other funding sources
like ECA and other banks through a syndicated B loan
WBs extensive lending and policy experience with Chad offered the leverage
that sponsors did not have
The project with potentially high returns and developmental impact for Chad
was also aligned with WBs policy objectives
WB facilitated extensive consultation process including supporters and
opponents: The process helped sponsors restructuring the project to minimize
the social and environmental impact (such as increasing the benefits to
indigenous people and changing the pipeline route to protect the natural
habitat)
WB also initiated a Revenue Management Plan to help prevent probable
misuse of Chads revenues by the Govt, and target them for developmental
purposes to increase welfare
Insisted on an open and transparent project planning process
Established capacity building programs to develop the infrastructure for a well-
functioning petroleum industry and investment climate in both Chad and
Cameroon
The role of World Bank:
WB involvement also ensured that sponsors did not abandon the
project due to huge political risks and looked instead for safer
opportunities in other countries, leading to a missed
opportunity for Chad
Without the WB, the Govt might turn to neighboring countries
such as Sudan and Libya for partnering in oil export. This
potentially would have adverse consequences in case the
project revenues were utilized to finance non-developmental
purposes such as war.
Such an alternative would mean longer and hence more expensive
pipelines
The projects exposure to social risks would increase, as the
pipelines would inevitably cross the northern part of the country
with social unrest and upheavals.


Subjects of opposition:
The environmental and social impacts were claimed to be irreversible
The revenue management plan was claimed to be flawed and to lack
effective oversight
Govt claimed to have little intention of allowing the plan to affect
local practice
Criticism on oversight committees composition and power
The RMP was a concept untested
According to Harvard Law School, Oil will not lead to development in
Chad without real participation, real transparency, and real oversight,
none of which currently exists
The revenue management plan also regarded as infringement of sovereign
rights
The sovereign rights controlled by undemocratic rulers versus people
The beneficiaries of the project were claimed more to be the corporate
sponsors and commercial banks, as opposed to people of Chad
Valuable funds could have been used in alternative causes, rather than
potentially strengthening a corrupt Govt


Assessment of Project Risks and Returns:
Chad
Benefits:
Project provides an important opportunity for Chad to reduce poverty, though
contingent on Govt commitment
Receive up to $125M per year from the project, increasing Govt revenues by more than 50%
Chad has few other alternatives if any for development
RMP provisions and future linking of developmental funds to Govt compliance may
deter potential misuse of project revenues by the Govt
Project helps leveraging WB and other financial resources which Govt could not have
mobilized by itself
Leveraging technical expertise of the reputable sponsors significantly reduces Chads
exposure to operational risks
Potential employment opportunities created for local people in operations
Environmental/social concerns seem to be well addressed in contingency plans with
extensive public consultation
Another positive externality may be WBs capacity building efforts to establish the
sufficient infrastructure for a well-functioning petroleum industry and investment
climate in Chad
Greatest protection from downside risk (i.e. price or volume risk) compared to
corporate sponsors, probably because bulk of the revenues (royalties) independent
from price or reserve levels.
Assessment of Project Risks and Returns:
Chad
Risks:
The realization of the opportunity for economic development strictly
dependent on Governments commitment in implementation of RMP
RMP is claimed to lack credible oversight and enforcement
mechanisms, which would work against the people of Chad due to
undemocratic and oppressive Govt in power
RMP was a concept yet to be tested with the project; even WB
admitted the project to be an experiment, which increases
peoples exposure to risk
Chad has to put its only natural resource into the project under project
finance structure and RMP, which considerably eliminates sovereign
discretion and flexibility
Impositions on the allocation of revenues may turn out to be
constraining for a future democratic government who wants to
implement other projects to the benefit of people of Chad
Governments compliance to RMP is a requirement for future WB
loans, which extends the potential influence of the project-specific
impositions and commitments to non-project specific areas,
increasing Chads exposure to risks
Assessment of Project Risks and Returns:
Chad
Risks:
Even if the project generates promised revenues for Chad, Chad might not gain
on an incremental basis, as it will no longer be eligible to certain types of
developmental funding due to increased revenues
Current aid is around $188M (Exhibits 7 and 8), which exceeds the
expected cash flow. Chad might not gain on an incremental basis due to
displacement of existing aid, and yet lose control on its single natural
resource
Environmental and social risks mostly remain with Chad
Some adverse impacts are either irreversible or extremely hard to fix
Despite contingency plans, there may be leakages in the pipeline that
would go unnoticed for long time, due to limitations of even the most
advanced technologies
Less share of the gains in the upside (though balanced with the highest
protection from downside risks)
Although expected to be a highest priority issue from Chads perspective, the
timing of cash flows were not negotiated to the advantage of Chad
Considering the urgent need for funds, the allocation of cash flows should
have favored Chad more in the initial years
Compared to the timing of cash allocations for other sponsors, the late
allocation might be perceived as unfair and might increase the chances of
expropriation
Assessment of Project Risks and Returns:
Sponsors (Exxon Mobil)
Benefits:
The presence of WB/ECA/IFC along with participation on
governments in equity financing significantly reduced political risk
exposure
Project might have helped portfolio diversification
Low construction risks (sponsors expertise and reputation in the
industry)
Low operating risks (positive NPV under most scenarios in Exhibit 5
with different price and reserve levels)
Low financial risks, considering the DSCR (as high as 2:1) and low
breakeven finding and development costs compared to price
The presence of WB/ECA/IFC in the deal, alignment of Govt
interests via equity ownership through project finance structure,
the linking of installment of future development funds to
Governments compliance to the RMP significantly reduced
political risk exposure. However,



Assessment of Project Risks and Returns:
Sponsors (Exxon Mobil)
Risks:
Back-loaded cash flows to Govt may be perceived as unfair and may result in
expropriation
Still chances are low, as Govt would not probably want to jeopardize future capital inflows
by risking its relations with WB and the rest of the financial community
The Govt would not want to forego serious amount of revenues in the form of dividends,
taxes, royalties.
Any social or political instability in either Chad or Cameroon would adversely effect
the export of oil through the pipelines across the two countries
However, the construction of pipelines underground may have helped reduce the negative
consequences of being exposed to such risk


Real options
Shadow costs: In case WB is not involved in the project, it is likely that the Govt will
go with Libya
Temporary stop option if oil price drops


Project Update
After WB approved the deal, President Deby used part of the proceeds to buy
weapons
Huge criticism by social activists/interest groups against WB and sponsors
WB responded by requiring that the proceeds should be repaid out of general
revenues, suspended new loan programs, and also set up a new oversight body
headed by external people
After these reforms, WB and IMF permitted debt relief to Chad

In December 2005, the National Assembly of Chad amended the countrys
Petroleum Revenue Management Law in the following ways*:
broadening the definition of priority sectors to include, among other areas,
territorial administration and security; and by allowing that further changes in
the definition of priority sectors can be made by decree;
eliminating the Future Generations Fund, thus allowing the transfer of more
than US$36 million already accumulated there to the general budget
increasing from 13.5 % to 30% the share of royalties and dividends that can be
allocated to non-priority sectors that are not subject to oversight and control
* Chad-Cameroon Pipeline Project, World Bank Web Site
Project Update
WB considered these changes a breach of contract, and on January, 2006,
it suspended new loans and grants to Chad, as well as disbursements
under eight ongoing IDA operations in the country.

The suspension automatically freezed the flow of part of Chads oil
revenues within the offshore escrow account

WB states in its web site that it remains in dialogue with the Chadian
authorities, and is determined to safeguard the oil revenues intended for
poverty reduction programs included in its original agreement with Chad,
while recognizing the fiscal strains currently experienced by the
government of Chad.