Some elements of pipeline financing
• High up-front costs, low and more or less fixed operating
costs, and a long payback period (generally > 10 years).
• In emerging economies, pipelines normally need to be
developed by oil companies. Specialized oil pipeline
companies, which prevail in the West, are generally not
interested in moving into more risky markets.
• Investments are so large that oil companies generally
organize themselves into consortia, which also include local
oil firms.
• Finance comes from the project sponsors (which fund
directly, or fully guarantee the debt), through project finance,
or (most often) through a combination of the two. Finance is
such a crucial element that the pipeline project needs to be
structured from the beginning with the ultimate financing
mechanism in mind.
PROJECT FINANCE APPROACH
• A Special Purpose Vehicle is set up to own and
operate the pipeline.
• This SPV is the borrower.
• Lenders rely on the creditworthiness of the
pipeline’s projected cashflow.
In a consortium, the various participants do not necessarily
agree on whether the pipeline should be funded from equity, or
through project finance. In practice, one often finds a
compromise by structuring part of the equity as debt. Eg. the
agreement is that 80% of the funds will be “debt”, and 20%
equity. Those who wish to make their full contribution as equity
would make 80% of this contribution as a loan, on the same
conditions as independent lenders get.
Advantages of project finance vs. equity finance
- Financially weaker companies in the consortium (especially local
ones) which may have difficulty in raising the needed investment
funds as equity are able to participate in the financing
- Project debt is off-balance sheet
- No pressure on limited equity, which can be used for more
profitable ventures (pipelines tend to be low-margin investments)
- outside pressure of financiers helps to discipline the various
parties involved in the pipeline construction, including
governments, tax authorities, etc.
- Multilateral lenders such as World Bank, IFC, EBRD or OPIC
can be brought in, which is a deterrent to nationalization.
Some key conditions for making project finance possible (1)
- Ownership structure: local governments should not be the majority
shareholders. Reputable (oil) firms should be the managers and operators of
the pipeline. To obtain ECA credit or guarantees, it may be necessary to
include certain oil companies in the project (most ECAs require a minimum
level of ownership from their national companies in order to grant loans/give
guarantees).
- Agreement on financing principles. Eg., when will the sponsors
become legally committed to invest? What will be the capital structure of
the pipeline company?
- Share transfer and asset pledge rights: the project company shares
should be freely transferable to third parties, and pledgeable to lenders
without restrictions.
- Pipeline fees: should be set to match the currency of funding (eg. in US$).
- Throughput reliability: the shipping agreements should be with strong
companies, and be of a longer term than the project loans. They should
include minimum volume guarantees - typically, through a T&D Agreement.
Some key conditions for making project finance possible (2)
- Cash flow mechanics: the pipeline tariffs should be paid in US$ into
offshore revenue accounts, to be assigned to lenders. The host country has to
provide Central Bank licenses for offshore accounts and hard currency loans.
There should be no mandatory requirements for the conversion of export
earnings into local currency.
- Terms of concession agreement. The host government(s) should not
put undue burdens on the project, eg. in terms of local content requirements.
Ideally, the tax regime should be locked in during the life of the financing. The
pipeline should be able to give preferential access to the shippers through whom
the financing has been made possible/is structured. Dispute resolution
mechanisms should specify international arbitration. All this is made easier if
the governments involved get a fair share of the project cash flow.
- Cash flow allocation priorities and controls. All cash flow in excess
of fixed operating costs and taxes should be prioritized for the project finance
lenders (and other senior loans)
Sources of project finance:
banks
bond market
or both
An example of a bond market financing (1996):
Transportadora
de Gas del Norte S.A.
(Argentina: BB rating)
Loan is onsold to Trust
International
Finance Corporation
BBB- S&P
BBB D&P
Trust
(USA)
Rating
agencies
Investors
Issuance of trust certificates backed
by the IFC loan.
• Maturity: 12 years (rather long).
•Coupon: 9.45 % (fixed): over 1% less
than what would have been paid on a
syndicated bank loan.
• Oversubscribed at 215 million US$.
TRANSACTION OVERVIEW: risks to
be managed to give comfort to financiers.
Will the
product
go in?
Will the pipeline
be built in time?
Will the
pipeline
continue
operating?
Who will buy the
product?
Do I get my
money back?
TRANSACTION OVERVIEW: risks to
be managed to give comfort to financiers.
Will the pipeline
be built in time?
PRECOMPLETION
RISKS
The lenders will generally require financial guarantees
from the project sponsors and construction companies,
eventually backed by other guarantees. At the
completion of the pipeline, these guarantees are
waived.
Generally, “completion” is widely defined, to include:
- physical completion (verified by an independent
engineering firm, and after all payments to contractors)
- legal completion: all permits are in place
- performance completion: throughput
has been tested for X days
- financial completion:
financial coverage ratios
meet pre-set criteria.
TRANSACTION OVERVIEW: risks to
be managed to give comfort to financiers.
Will the pipeline
be built in time?
These guarantees need to address the following risks:
PRECOMPLETION
RISKS (2)
• What happens in the case of environmental or
regulatory disputes?
• Cost overruns: how will these be covered?
• What happens if regulatory approvals are delayed,
resulting in missed completion dates - who is liable?
• Design/performance failures - independent technical
consultants need to look at the technologies used.
• Political risks, in particular “creeping
expropriation”.
Risks to be managed to give comfort to
financiers: POST-COMPLETION RISKS
Will the
product
go in?
Independent
evaluation of
Will the
the size of
pipeline
reserves, and
continue
the certainty
operating?
of future
production
volumes.
• An independent engineering consultant
has to review the operating systems design.
• Review of legal risks.
Who will buy the
product?
Do I get my
money back?
TO GET THE MONEY BACK
Pipeline income is normally comprised of a fee
per barrel of oil transported over a certain
distance. As operating costs are largely fixed,
pipeline economics are strongly sensitive to the
volume of oil transported, and changes therein.
For this reason, lenders generally require the
pipeline company to have
• either a long-term throughput and deficiency
(T&D Agreement) with financially strong oil
companies; or
• financial guarantees from creditworthy
counterparties to make up for any shortfalls in
pipeline earnings.
TO GET THE MONEY BACK (2)
Managing the risks through offtakers
Who will buy the
product?
Do I get my
money back?
• Counterparty risk
• Currency risk
• Currency transfer risk
• Market risk
Chain-linking may be a solution:reimbursement can
be through:
• The original buyer (e.g., of gas); or
• A customer of this buyer (e.g., an electricity plant,
or a fertilizer company); or even
• A customer of this customer: e.g., a mining or
metals company using electricity.
Oleoducto Centrale S.A. (OCENSA), Colombia
Pipeline
users
Transport
tariffs, paid
through an
offshore
account
Pipeline
Funding of
pipeline
construction
OCENSA
Sponsors’
loans and
equity 2 billion US$
Rating: BBB
Amount: US$ 150 million
Life: 1995-2005
Ecopetrol
(BBB)
Guarantee to pay an advance
tariff if there is insufficient cash
flow to service the debt,
irrespective of actual flow of oil
Sale of debentures
Investors
150 million US$
OCENSA was established, in Colombia, for the explicit purpose of
purchasing, constructing, owning, operating and financing an 800
km pipeline between the new fields o Cusiana/Cupiaga and the
export port of Covenas. Debt service would normally be through
offshore payments by a range of oil companies for use of the
pipeline, but this was backed up by an unconditional guarantee
from Ecopetrol.