Project Financing Definition

The International Project Finance Association defines

Project finance as financing of long-term

infrastructure, industrial projects, power plant, etc.,
where project debt and equity used to finance the
project are paid back from the cash-flow generated by
the project.
The two key aspects of project financing are:
1. The project revenues (cash flows) are expected to
service debt or equity interest taken by the providers
of capital.
2. The loans are secured by the project assets or, to
the extent security interests are restricted or have
limited value, are secured by contingent support
from sponsors and other project participants.

Sources of Funds
Funds for project financing comes from variety

of sources: such as:

equity capital,
governmental aids,
loans, which can be export (Eurobonds,
private placement and commercial papers),
loans at favorable terms from development
institutions such as the World Bank or the
Agency for International Development,
loans from multilateral agencies (IFC, ADB),
commercial bank term loans or loans backed
by export credit guarantees.

Project Financing Risks

GENERAL RISK
Completion Risk
MARKET RISK
FEEDSTOCK RISK
POLITICAL RISK
FORCE MAJEURE
PERMITS
SPONSOR RISK
LEGAL RISK
ENVIRONMENTAL RISK

Foreign exchange risk

Interest rate risk

General risks
May be related to deficiencies in the feasibility studies: Too often

preliminary studies fail to show upside potential and downside risk of the
project.
Many developing countries, have spent time and money studying or
constructing projects that turned out to be unfeasible. For example,
During the late 1970s and early 1980s, there were a substantial number of
white elephant projects undertaken in developing countries for reasons
relating more to national pride and other social considerations than to
economic viability.
Projects that succeeded in the 2000s, are likely to be governed primarily
by market driven considerations.
The World Bank and the European Bank for Reconstruction and
Development will finance feasibility studies, as will the Overseas
Private Investment Corporation (OPIC).

Market Risk
Related to the assessment of whether market exists for the energy produced.

This part of the feasibility study is therefore key to the success of the project.
Cash flow projections may be affected by a number of factors, such as
economic and industry cycles, demand from the retail and whole sale end users
driving request for electrical power.
Competition from other producers, albeit non-existant in the emerging markets.
Market risk could be mitigated to some extent by putting in place contractual

assurances.
Two major types of agreement can be entered into, and these are: take or pay
contracts or tolling agreements.
Take or pay contracts are contracts (generally used for commodities like
electricity, oil and gas). In a typical take or pay contract structure, the contract
is entered into between the project company and the buyers, but all payments
arising from the contract are assigned by the project company to the lenders.
Production payment agreement (PPA). The financial effects of such
contractual scheme are those of a financing arrangements (taking equity
interest) through the purchase of a stake in the economical activity of the
project. Such assignment guarantees the right to receive part of revenues
generated from sales of electricity, up to retirement of the debt.

Tolling Agreement

Tolling agreements are agreements to put a specified amount of raw material per period
through a particular processing facility. The toller, who is going to be the purchaser of
electric energy (Dispatching), provides the toll processor (Power Plant owner) the natural
gas for the production of electric energy and generally pays for transportation costs to the
power plant. In this contractual scheme, therefore, both the fuel availability risk and the
fuel supply risk are to be borne by the toller, while the toll processor is involved
exclusively in the productive process.
The toller pays the toll processor a fee (called toll)
Clearly, the tolling agreement is closer to a conversion contract (or a service contract)
than to a sale: the power plant does not sell energy, the toll processor is therefore a servicer
and not a seller.
Usually, the toll processor shall:
Generate electrical energy with the gas or oil supplied by the toller,
Supply energy exclusively (optional) to the toller;
Hold the gas in custody on the tollers behalf.

Usually, the toller shall:

Supply natural gas and fuel oil;

Absorb electric energy in the determined amount or (optional) in minimum
amounts (take or pay clause);
Pay the toll processor for the energy supplied, which usually includes:
a conversion fee (for the service);
a capacity availability fee; a fee for other services rendered by the toll processor connected
to the energy generation.

Feedstock Risk
Related to the availability of feedstock (be it oil,

natural gas, water etcetera).

Power plants require significant amounts of fuel to
operate on ongoing basis, it is key to the success of
the project to make sure that such fuel is available
and will remain available during the operation of the
plant.
In order to limit such the availability risk, lenders will
normally require long-term supply contracts with the
principal suppliers to ensure adequate supplies of the
necessary volume and quality of feedstock at prices
consistent with the financial projections for the
project.

Political Risk
Political risks may be considered a sub-category of force majeure

events. Political risks represent a significant factor in structuring the

financing of a developing country power project.
Such risk may include:
Terrorism, war, civil war, rebellion, revolution;
Prevention of, or delay in, the payment of external debt by the host
government or by that of a third country through which payment must
be made;
Expropriation by the host government, either of equity debt interests
or assets, or even bank accounts;
Cancellation or non-renewal of export licenses;
Actions or failure to act by governments in breach of international law,
causing delay or stop in payments;
Destruction of all or part of the manufacturer's assets or debt servicing
ability, or interruption of the manufacturer's operations.

Force Majeure
Force Majeure is a risk of a prolonged interruption of

operations for period after a project finance project

has been completed due to fire, flood, storm, or some
other factor beyond the control of the projects
sponsors.
Force majeure risks are circumstances that are not
within the reasonable control of the parties. The acts
beyond the control of the contractor, including acts of
God, natural disasters, insurrections, civil disorder,
strikes as well as political violence and other
political acts

Permits
Permits are usually the responsibility of the

sponsors or contractors. In order to attract

lenders to the project, sponsors and
contractors must be able to show that they
have fully analyzed the regulatory structure of
the host country and acquire, all necessary
permits to get the project underway.

Sponsor Risk
Lenders analyze in depth sponsors and other

participants strengths and weaknesses. Such

analysis usually focuses on the strict financial
strengths of the sponsor, such as
Balance sheet strength, proforma and projected
earnings performance, and managerial skills of its
directors.
The analysis of the track record of the sponsors in
similar projects, and focuses also on examining, last
but not least, the political support for the project,
which is paramount.

Legal Risk
The contract should be carefully drafted to include provisions of governing

law and
consent to foreign jurisdiction. In case the consent to foreign jurisdiction is
agreed, it will be necessary to ascertain whether local government will enforce
and recognize foreign decision, or will tend to retry the matter in the court.
In some developing countries issues of sovereign immunity arise. Sometimes
sovereign nations refuse to acknowledge foreign jurisdictions. Usually a
provision waiving sovereign immunity both as to the arbitration and the
enforcement of the arbitral award is included in contracts. It would be
desirable to insert arbitration provisions in the contract, even though lenders
are usually not willing to derogate to court jurisdiction.
Sponsors will usually insist for negotiating an arbitration clause or by
applying
international conventions, such as the Convention on the Settlements of
Investment Disputes Between States and Nationals of Other States (ICSID),

Environmental Risk
Projects In the past, were largely constructed with

little regard to environmental issues or the adverse

social impact of the project on local populations.
Lending institutions, host countries and sponsors are
focusing much more attention on these issues today
and in the future, particularly for projects that involve
the production of significant hazardous waste.
As developing countries do not currently have a
detailed codified body of environmental law, lenders
will require project compliance with
international environmental standard such as the
World Bank guidelines or the standards from
environmentally advanced countries, such as the
U.S.

Financing project
Financeability of projects depends on country risk

availability, mitigation and ratings.

The role of Export Credit Agencies & Development
Agencies will be crucial.
Capital markets will play a minor role in project
financing, especially in sub-investment grade countries.
Introduction of new insurance products may encourage
both Bank & Capital Market Debt,
Domestic banks should play a greater role with local
currency financing, overall project financing will become
more expensive when available for emerging market
economies

Benefits of PPP
Cost saving
Expedited completion
Improved quality and system performance
Substitution of private sector resources for

the constrained public resources

Access cheaper source of funding

PPP Advantages
Accelerating the implementation of high priority

projects.
Transferring private sector comparative advantage in
procurement of service and technology to the public
sector.
Delivery of new technology, engineering, design, etc
Reducing the role of government and encouraging
privatization.
Innovative financing offered by private sector for
funding public projects

PPP Domain of Responsibilities & Options

Design
bid,
build

Private
contractor
fee basis

Public Ownership

Design
build

Build,
Operate,
Transfer
(BOT)

Design, Build,
Finance, Operate
(DBFO)

Private Ownership

Build,
Operate,
Own
(BOO)

Definition BOT
The build-operate-transfer (BOT), build-operate, and

own BOO, and design-build-operate-maintain (DBOM)

model is a form of public private partnership PPP that
combines the design and construction responsibilities
with operations and maintenance. These integrated
PPPs transfer design, construction, operation and
maintenance of a single facility or group of assets to a
private sector partner. Responsibilities
A single design-build-operate contract for the entire
project with financing secured by the public agency,
under which the contractor provides long-term
operation and/or maintenance services, with the public
sector sponsor retaining the operating revenue risk and
any surplus operating revenue.

BOT
Build-operate-transfer
Public Sector (owner)
Public Sector/Owner

Engineering
& Design

Contractor
Operator

Funding
Vehicle

Toll from
project by
end users

DBFO
The Design-Build-Finance-Operate (DBFO) contract,

where the responsibilities for designing, building,

financing and operating are transferred to private
sector partners.
Various risks in the various stages are transferred to
the private sector
With respect to the degree to which financial
responsibilities are actually transferred to the private
sector, there is a great deal of variety in DBFO
arrangements in the United States and Europe,.
Practically all DBFO projects are either partly or
wholly financed by debt leveraging revenue streams
dedicated to the project.

DBFO Approach

The DBFO approach transfers responsibilities for designing, constructing, financing and
operating projects to the private sector, allowing it to consider these obligations as an
integrated whole throughout the contract period. A 30-year term was chosen in order to
maximize the benefits of this so-called whole-life costing approach.

The objectives for embarking the DBFO initiative are:

to minimize adverse environmental impacts while maximizing benefits for motorists;
to transfer various risks to the private sector;
to promote technical, operational, financial and commercial innovation;
The shadow toll approach has also proven attractive for investors. Its main benefit is that
it minimizes traffic risk. Given that drivers themselves do not have to pay tolls, their
choice of travel path is made solely based on time, distance, and convenience, and is
therefore much easier to predict.
The United Kingdom maintains extensive records of traffic volumes and this data has
enabled concessionaires to project revenue streams accurately enough to obtain financial
guarantees from AAA-rated insurance companies, enabling concessionaires in turn to
float their own AAA-rated bonds.

DBFO
User fees (tolls) are the most common form of revenue stream.

However, others ranging from lease payments to shadow tolls and

vehicle registration fees.
Future revenues are securitized to issue bonds or other debt that
provide funds for capital and project development costs. The public
sector may provide grants in the form of cash or contributions in
kind, such as right-of-way. In certain cases, private partners may be
required to make equity investments as well.
In Europe, Latin America, and Asia, where the DBFO approach is
commonly used to develop new toll road projects, the debt is issued
by private concession companies who are fully responsible for
designing, building, financing, and operating the projects.
It is often more cost-effective for public project sponsors (in the
USA) to issue debt than their private sector partners, because of
their ability to issue low- interest tax-free debt.

Definition DBOM
Responsibilities

DBOM is a public private sector contract for

procurement of public goods, where as
project financing is secured by the public
agency, under which the contractor provides
long-term operation and/or maintenance
services, with the public sector sponsor
retaining the operating revenue risk and any
surplus operating revenue.

Definition BOO
The build-own-operate model, a private company

is granted the right to develop, finance, design,

build, own, operate, and maintain a project.
The private sector partner owns the project
outright and retains the operating revenue &
risk and all of the surplus operating revenue in
perpetuity. While this approach is more common
in the power and telecommunications, it has also
been used to develop transportation
infrastructure.

Design-bid-build
Is the traditional project delivery approach that was

used for most of the 20th century to procure public

goods.
The design-bid-build model unbundles design and
construction responsibilities by awarding them to a
private engineer and a separate private contractor.
By doing so, design-bid-build separates the delivery
process into three phases:
1) Design,
2) Bid, and
3) Construction.

Project Delivery
four major components of project delivery
1.
2.
3.
4.

are:
contracting
compliance with environmental requirements
right-of-way acquisition
project finance

Types of private sector involvement

Types of private sector involvement in

infrastructure development contracts:

Contracting out
Private financing of public facilities
Leasing
Joint ventures
BOT
DBFO
BOO
Privatization

Phases of a PFI Project

Identification
Tender Prepared by Government for

qualified bidders
Selection
Development
Implementation
Construction
Operation
Transfer

Project Phases
Economic framework
Governments role and support
Transfer technology and capacity

building
Procurement issues
Financial and economic appraisal
Risk management