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RISK-MITIGATION STRATEGIES

IN MEGA PROJECT: Learning

From Past Experience

Ghazali Ab Rahman

School of Economic, Finance & Banking

Department of Banking & Risk Management

Universiti Utara Malaysia

Understanding Project Risks

and How You Manage Them

MARINE Seminar, 13 May 2015

MARIM

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1. The Big Picture.

2. Corporate Vs. Project Finance

3. History of Project Finance.

4. Major Risks.

5. Risk Management Strategies.

6. Lessons for the way forward.

CONTENTS

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We leadTHE BIG

PICTURE

3

Region Project

Count

Investment

(Billion USD)

Latin America and the

Caribbean1,586 672.5

East Asia and Pacific 1,564 336.7

South Asia 771 320.7

Europe and Central Asia 742 289.1

Sub-Saharan Africa 436 121.1

Middle East and North Africa 139 85.9

1.826 Trillion

PPP 1995 - 2011

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PICTURE

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Sector Project

Count

Investment

(Billion USD)

Energy 2,283 630,414

Transport 1,371 310,002

Telecom 822 820,622

Water and sewerage 762 65,164

1.826 Trillion

PPP 1995 - 2011

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CORPORATE FINANCE VS.

PROJECT FINANCE

Two ways to

finance a

corporate

project1

Using a Project

Finance Concept

Using Corporate

Finance concept

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Corporate Finance

Project Finance

Corporate

Project

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Corporate Finance Toshiba borrows money

to construct a project

(constructing an Art

Science Factory)

BANK

LOAN

REPAYMENT

The whole Balance Sheet of Toshiba

Is pledged to the bank.

CORPORATE FINANCE VS.

PROJECT FINANCE

1

2

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Debt/T Capital from 1,799 companies:

Mean 33.1%

Median 30.5%

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Project Finance

In case project fails, sponsors only lose their 30% shares.

Their Balance Sheets escape creditors’ claims.

CORPORATE FINANCE VS.

PROJECT FINANCE

PROJECT

VEHICLE (PV)

- As borrower

- As implementer

- As operator

- Repay from CF

- Recover from assets

(as security)

BANKS

Syndicate

Multilateral,

Bilateral,

other lenders

70%

Set-up & hold 30% Share Capital in PV

Loan

s

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Debt/T Capital from 1,050

companies:

Mean 70%

Median 70%

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Full Spec.

CORPORATE FINANCE VS.

PROJECT FINANCE

PROJECT

VEHICLE (PV)

- As borrower

- As implementer

- As operator

- Repay from CF

& assets

SPONSOR A SPONSOR B SPONSOR C

BANKS

Syndicate

d

Multilateral,Bilateral,

other lenders

70%

Set-up & hold 30% Share Capital in PV

Host Government

EPC Contractor

O&MContractor

Off-Taker

Loan

s

8

We leadHISTORY OF PROJECT FINANCE

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1299:Devon Silver Mines (English Crown).

1500’s:Dutch East-Indian Co. &British East-Indian Co.

1860’s:Suez Canal.

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CORPORATE FINANCE VS.

PROJECT FINANCE

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CORPORATE FINANCE VS.

PROJECT FINANCE

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CORPORATE FINANCE VS.

PROJECT FINANCE

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RISKS

This

discussion

focuses on

the first

three risks

Corporate

Project

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Mitigating Strategies

Use PF structure (see slide 8). US$3.7b Chad-Cameroon Pipeline. CLICK

Minimize financial commitment– High-

Leverage with Limited-recourse or

non-recourse. CLICK

INSOLVENCY

RISKS

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Mitigating Strategies

Choose well-rated co-sponsors with

adequate expertise.

Use proven technology. US$5.5b Iridium failed due to unproven

technology.

Commit Host Government –

Implementation Agreement (IA). €934m Poland’s A2 Motorway. CLICK

INSOLVENCY

RISKS

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Mitigating Strategies…….

Get the off-taker to buy the project: US$13b Airbus A380 – multi-government off-

takers.

£9.5bn Euro Tunnel & US$2.3 billion Disneyland

Paris ‘failed’ mainly due to no off-takers.

Use Hell-or-High-Water Clause. Party must do what has been agreed with no

contractual defense.

Take appropriate insurance.

INSOLVENCY

RISKS

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Mitigating Strategies

Engage sponsors with high political

cloud. IFC loans in Chad-Cameroon Pipeline & in

USD$2b Mozal Project. Giant companies from USA, Europe, Japan, etc.

Leverage on technology to avoid

CEND Mozal Project, Chad-Cameroon & US$2.4b

Pertozuata in Venuzuela.

POLITICAL RISKS

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Mitigating Strategies……

‘Internationalize’ the project. Mozal Project:

POLITICAL RISKS

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Input From

Power & Management S. Africa

Alumina Australia

Petroleum, liquefied pitch, etc. Abroad

Technology France

Financing UK, Japan, US

Purchasers of end products Overseas

Sale proceeds & Debt Reserve Ac Trustee A/C overseas.

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Mitigating Strategies…….

Involve Multilateral & Bilateral Org. World Bank’s Environmental Analysis in

Chad-Cameroon Pipeline & Petrozuata.

IFC for Project Evaluation.

ECA (USA & French) - Chad-Cameroon Pipeline,

Mozal Project & Petrozuata.

POLITICAL RISKS

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Mitigating Strategies…….

Firm control over outputs Airbus A380 – JV bet, UK, France Germany &

Spain to beat Boeing and impede US threat.

Petrozuata – Process outputs in Louisiana, USA.

Use sponsor’s own laws, US laws or international laws.

UK Law in Poland A2 Motorway. US Law in Chad-Cameroon, Mozal &

Petrozuata.

POLITICAL RISKS

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Mitigating Strategies…….

Use Hell-or-High-Water Clause

Implementation Agreement: Not to change law, tax rate, etc.

Take Political-Risk Insurance: CEND. Force majeure.

Terrorism-Risk Insurance.

Currency-devaluation Risk Insurance.

POLITICAL RISKS

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Mitigating Strategies…….

Accurate evaluation of CF: Use sophisticated models – Monte Carlo,

Probability Analysis, Possibility Analysis, etc.

Well-crafted & extensive Financial Model

Conservative pricing:

US$10 per barrel in Chad-Cameroon Pipeline.

US$11 per barrel in Petrozuata.

RETURN RISKS

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Mitigating Strategies ……

Liquidated damage: Turnkey Contract on EPC Contractor.

Guarantees – Tender, Performance, etc.

Control over Cash Flow CF Waterfall. CLICK

High Debt Service Ratio (DSR) CLICK

Reserve Account to meet payment obligations.

Maintenance Reserve Account.

RETURN RISKS

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Mitigating Strategies ……

Minimize cost of borrowing:

Engage high-rated sponsors.

Use appropriate hedging tools.

Include ‘ITF’s financing’ to signal strength.

Use contracts to protect revenue: Supply-or-Pay Contract – on suppliers

Take-and-Pay Contract – Plus Highway

Hell-or-High-Water Clause

RETURN RISKS

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Mitigating Strategies ……

Use contracts to control behavior: Agency problem over Cash Flow.

Use Guarantee to enhance return: Partial Credit Guarantee – covers private lenders

against all risks, allows to extend maturities and

improve commercial terms.

Partial Risks Guarantee – protect lenders when

government fails to perform contractual

obligations.

RETURN RISKS

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Mitigating Strategies ……

Use suitable organization Build-Own-Operate (BOO) – Oil.

Build-Transfer (BT) – Risky project.

Build-Operate-Transfer (BOT) – Highway. Build-Develop-Operate-Transfer (BDOT) -

Highway.

RETURN RISKS

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Mitigating Strategies ……

Use hedging tools: Mozal

Price of Power & Alumuna tied up to London Metal

Exchange price (when output price falls, costs of input

also falls/sufficiently hedged).

Other Mega Projects Interest-rate risks -Interest-rate swap, interest-rate

forward, future, option, etc.

Currency risks – currency swap, futures or option.

Exchange-rate risks – FX forward, swap and option.

Price risks – commodity forward, future or option

contract.

RETURN RISKS

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The Way Forward to Managing Risks

SOME LESSONS

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1 • Lots of creativity & innovation.

2• Use ‘Negotiation’ as powerful

weapon for risk management.

3• Allocate risks to parties best

able to manage risks.

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Thank you for your attention!

THAT’S ALL….

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