Project Finance for Infrastructure

Projects

Week 2: Structuring an infrastructure project to

raise project finance

Dr Patrick Manu, Senior Lecturer in Project Management

School of Mechanical, Aerospace & Civil Engineering
Room E11, Pariser Building
Email: Patrick.Manu@manchester.ac.uk
Twitter: @DrPatrickManu
 Objectives of the Session

1. Recap of key features of project finance

2. Setting up the project finance

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 Quick Exercise – 5mins
Question: Which of the following is NOT a
feature of project finance?
a) Relies on sound income stream of the project
b) Lender has limited recourse to assets of
sponsors
c) Repayment of loan backed by balance sheet of
sponsoring company
d) Uses a variety of financial instruments

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 Key Features of Project Finance
Non-recourse
funding
Complex Off-balance
Contractual sheet
Arrangements transaction
Special Purpose
Vehicle (SPV)
Allocation of Sound income
risks stream of the
project

Variety of
Variety of Financial
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Participants Instruments
 Objectives of the Session

1. Recap of key features of project finance

2. Setting up the project finance

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 Setting up the Project Finance

 Project finance transactions

– complex
– numerous players
– interdependent relationships

 Brought together to undertake a complex, risky project

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 A typical structure of a project
finance
Principal
(say host
government)

Concession
Agreement Off-take
Supply Contract Users
Suppliers Contract

Operation
Lenders
Loan SPV Contract Operator
Agreement

Construction
Shareholders Contract Constructor
Investors Agreement

Adapted from Merna and Smith, 1996

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 A typical structure of a private
finance

SPV

Project company, known as SPECIAL PURPOSE VEHICLE (SPV)

Formed specifically to build and operate the project

Structured as a limited project company or a joint venture
(JV) consortium

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 A typical structure of a private
finance project

SPV is independent legal entity

SPV enters into contractual agreements with number of parties

necessary to the project

These agreements form framework for the project AND control

the allocation of risks

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 Concession Agreement

Principal
(say host
Governs relationship with host government
government)
SPV will enter negotiations with the host government
Concession (often called principal) to obtain all required permits and
Agreement
authorisations
 Oil or gas production license
 Mining concession
SPV
 Permit to build and operate a power plant

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 Concession Agreement contains
Rights and obligations of sponsors and host government

Technical and financial requirements of construction,

operation and maintenance of the project

Length:10-20 years for process facility and 20-55 years for

infrastructure project

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 Relationship to lenders

Lenders
Loan SPV
Agreement

A syndicate of banks will loan funds to the project company

e.g. Eurotunnel project financing involved 220 banks
•One lender alone cannot provide the size of loan required
•Limits risk to any one lender

Different types of lending bank

International and local banks
International agencies - World Bank etc.

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 Relationship to shareholders

Shareholders
Shareholders SPV
Agreement

 Shareholders agreement governs relationship between different shareholders

 Shareholders can be sponsors, institutional investors and/or private investors

 Shareholders may have differing interests, e.g.
 Investment timeframe
 Required rate of return
 Level of day to day management of SPV
 What to do if additional equity capital required

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 The construction contract
Construction
SPV Contract Contractor

 Turnkey construction contract preferred by lenders

 Also known as EPC (Engineering, Procurement and Construction)

Under EPC, the SPV transfers construction risk to the contractor in exchange
for a set price
The Contractor guarantees
Completion date
Cost of works
Plant/facility performance 14
 The operating contract

SPV Operating
Contract Operator

 Governs the operation and maintenance of the facility

 Experience and reputation of operator is key
 Two forms of operating & maintenance contract:
Fixed price contract – operator is paid a periodic fixed price to operate and
maintain the facility. Operator bear risks of fluctuation in operating costs.
Pass through contract – operator receives fixed payment with an element of
performance bonus, while the operating cost remains the responsibility of the
SPV.
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 The supply contract
Ensures uninterrupted supply of
Supply raw materials to the project
Contract

SPV  Supplier sells the SPV agreed

volumes of input at pre-agreed
prices (with adjustments for
inflation, costs of raw material etc)

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 The off-take contract
Off-take
SPV enters into contract with Contract

purchasers of facility output

SPV
Long term contract whereby SPV
commits to deliver set volume of output
to purchaser (off-taker,) who agrees to
pay set sum of money for set period of
time Examples
 Electricity produced by power plant
Price linked to inflation index,  Metal output of cobalt/nickel mine
consumer price index, etc

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 Class question

What is the main reason for the complex structure of a Project Finance
arrangement ?
a) There are several different parties involved
b) It makes a lot of money for lawyers and accountants
c) It enables project risks to be allocated to the parties best able to
manage them
d) It is a legal requirement for project finance

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 Hinkley Point C Nuclear Power Plant

https://wakelet.com/wake/0081779d-aa4d-
49fd-a22c-e84763d29039

Source: MACE Group

Design, construction and operation

of two 1.6GW EPR nuclear reactors

Will provide 7% of UK electricity

needs for 60 years

https://www.youtube.com/watch?v=UMvMpM0EL_4 19
Source: APM
Source: EDF

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 Hinkley Point C Nuclear Power Plant
Investors

EDF Energy CGN Consumer

Electricity Suppliers
66.5% 33.5%
Shareholders
Agreement National Grid
Source: EDF Uranium
Supply Off-take
Contract Contract
Suppliers

Operation
SPV Contract EDF
Lenders Loan NNB
Agreement
HOLDCO
Lang O Rourke
Construction
Contract
/Costain /AREVA etc

NNB
GENCO
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 Other parties in project finance
Principal

Financial advisors Regulatory Agencies

Concession
Agreement Off-take
Suppliers Supply Users
Contract Contract

Lawyers
Operation
Lenders Loan SPV Contract Operator
Agreement

Construction
Investors
Shareholders Contract Constructor
Agreement

Equity Investors Independent Engineers

Adapted from Merna and Smith, 1996

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 Other parties in project finance
Advise on structure, contracts, local laws and
Lawyers regulations
 Experienced international law firms
 Each party has own lawyers – sponsor, SPV, banks

 Assess project feasibility for both sponsors and lenders

Independent Engineers
Monitor progress through engineering and construction
phase
 Assist in acceptance testing of facility
 Ongoing monitoring of operation of facility

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 Other parties in project finance
 Advise on how to arrange finance – streaming cash-
Financial advisors
flows, tax avoidance, use of offshore companies
 Preparation of information memorandum to raise
finance

Lenders or project sponsors who do not want active

Equity Investors management role in project.
 Allows them to participate in upside of project

Regulatory Agencies
Project requires permissions and licenses before
committing financial resources

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 Objectives of the Session

1. Recap of key features of project finance

2. Setting up the project

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 Major Disadvantages of Project
Finance
 Expensive to set up
 Lengthy to execute
 Highly restrictive once all contracts are in place
Typical project may have 40 more contracts uniting 15 parties
from input supplier to output purchaser

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 Inspite of this………..

 Project finance is an efficient way to finance certain assets

– Large tangible assets with limited lifetime
Risk is transferred from sponsor to other parties better placed to
manage the risks
 Parties sign up to long term contracts to incentivise behaviour
Increased chances of delivering project on time, on budget and
to required specification

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 Objectives of the Session
1. Recap of key features of project finance
2. Setting up the project finance

BP AMOCO case study quiz opened at 01:00 on 2nd

October 2018

Bb Assessment 1 opens at 01:00 on 9th October

2018 and closes on 16th October 2018

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Any questions???