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.