By David Tournier
, General Manager & Corporate Secretary, IFFCO Canada Enterprise
Project Finance is generally provided on a non-recourse
or limited recourse
basis, via the incorporation of a specific purpose vehicle (SPV)
, in an effort to insulate the sponsors of an industrial project from the risks of extraordinarily large or complex ventures. Because the usual guarantees do not play a central role in that context, it is essential for the project to be structured so as to secure a sufficient volume of cash flow to cover the project's operating cost and the repayment of the debt incurred by the SPV over the agreed tenure. This translates into very practical constraints that must be addressed by the executive team in charge of assembling a sound contractual structure. Sorting out these constraints takes any sponsors a long way on the road to the bankability of their project. They may not get everything in order. But the further they remove risks for the lenders, the fewer guarantees they will have to provide and the more debt they will be able to raise. A satisfactory assessment of those core elements should thus be a prerequisite to any commitment to an industrial project, be it as a lender, a shareholder, or a contractor.
In the first part of this article
, we have examined how the feedstock of industrial projects should be procured so as to enhance bankability. Not only should the feedstock be acquired at an affordable and foreseeable price: the choice of the project's provider and of its location should be made so as to greatly reduce risks associated with availability of the feedstock in sufficient quantity and with its transportation up to the project's site. In the second part of this article
, we sought to enhance bankability in the the negotiation of the contract for the Engineering, Procurement and Construction (EPC)
of the project. Price certainty, performance of the contractor, and on-time delivery are to be secured both within the agreement through liquidated damages, financial guarantees and other carefully negotiated clauses (Force Majeure, Scope of Work, Change Ordersâ€¦) and without the agreement, including by retaining proven technology and solvent contractors to execute a well-conceived plan based on sufficiently detailed preliminary engineering. In this third and final part, we address the purchase of the project's future production and other considerations that may affect bankability.
Third Milestone: Offtake Required for Take-off
Once the price at which the feedstock will be acquired is ascertained, and the capital costs for the construction of the envisioned facilities are identified so as to firm up a certain EPC price, the last essential piece in securing a project's cash-flow is the sale of its future production. This last piece can be facilitated by the nature of the project, for example energy plants benefitting from a long-term power purchase agreement entered into with a sovereign entity. Also, demand for some industrial outputs, such as a mine's gold or a well's oil, is so deep and liquid that lenders and investors will be comfortable to simply rely on the SPV's ability to place its product on the market. In many instances however, one or more entities (which can on occasion be picked among the project's sponsors) must commit in advance to purchase the whole production, or at least a portion of it which is sufficient to cover the future operating costs of the projected infrastructure and the repayment of the debt incurred for its construction. Those purchasers and the SPV enter for that purpose into an Offtake Agreement
, the terms of which are closely analysed by the potential lenders and investors.
Obviously, the commitment to offtake the project's output must be firm, and any clause providing a way out of that commitment must be eliminated or limited to the extent possible. Here again, clauses dealing with Acts of God or Force Majeure deserve utmost attention, and our earlier comments regarding such clauses of the EPC Agreement are also relevant to the offtake. But above all, the Offtake Agreement will affect the project's bankability via the selling price negotiated among the parties. That price must be low enough to ensure competitiveness and sustainability for the purchaser, yet high enough to provide the project's SPV with the required cash-flow and expected return on investment, at least until complete repayment of the debt incurred for construction. Ascertaining that price can be achieved through hedging, which triggers financial guarantee requirements and other potential financial costs that are imposed upon the SPV and weigh on the project's funding. Our observations regarding hedging in the context of feedstock procurement and made in the first part of this article are applicable here mutatis mutandis. Hedging is not always available however, in particular when the market for the relevant production is not sufficiently liquid.
Alternatively, the offtaker (purchaser) can agree to a fixed price or permit a certain fluctuation of that price above a floor price (minimum price) sufficient to cover both the operating costs and the debt service
. In that alternative, the solvency of the offtaker becomes critical to bankability, since the SPV's ability to repay its debt rests on the offtaker's capacity to purchase the required volume of the project's output for the duration of the credit agreement (and ideally a few years beyond term, so as to facilitate the debt's refinancing). It is particularly difficult to conclude such an agreement when the anticipated production is an easily available commodity prone to high volatility. In that context, an offtaker agreeing to a fixed or floor price would indeed expose himself to important competitive and financial risks. Taking these risks can be justified however if they permit construction of the facilities and result in the strategic advantage of owning the assets producing that commodity. That is why it is not uncommon for the offtaker(s) of an industrial project to be found among the SPV's shareholders.
When the project's output is sold as a service (such as is the case for a toll highway, an airport or a hospital), bankability will rest on a different form of agreement guaranteeing sufficient revenues. For example, a Public Private Partnership
will generally comprise a commitment from the public entity (government, municipality or otherwise) to pay the operator of the plant for the use of the completed infrastructure. The tenure of that agreement and the price paid under it will be determined in accordance with financial considerations similar to those applying to an agreement for the offtake of an industrial production.
Other Bankability Considerations: So Many Ways to Close
Environmental and social acceptability has become a central concern for any investor, as regulators worldwide have developed processes to ensure that acceptability is demonstrated prior to the issuance of the permits required to start construction of a project. Such permits being invariably a condition precedent to the disbursement of borrowed funds, that acceptability conditions the bankability of any project undertaken in such regulated jurisdictions. A carefully planned process allowing for a meaningful communication with the local population and authorities is often the difference between success and failure in that respect. That process must be started very early and coordinated with the engineering activities, so that the project's design may evolve as required to gain acceptability.
Benefitting from a clear regulatory framework in that and other respects is also very important. Investors and lenders will seek certainty of process and foreseeability as to the issuance of the permits required for the procurement, construction and operation of the project. Similarly, projects are far easier to undertake in jurisdictions that are politically stable and offer greater protection of the invested capital.
A satisfactory Operation and Maintenance Agreement is also of the essence where the SPV will own but not operate the future plant. The fruit of the capital invested into the project should be entrusted to the care of an operator whose expertise and credibility can help convincing the financial community to take part in that venture. As is the case for all counterparties to material agreements (feedstock provider, EPC contractor, offtakerâ€¦), that operator's solvency is also important from a bankability perspective since one should ensure that it will be able to comply with its obligations to the SPV over the long-term.
The structure of the financing itself may be enhanced, for example by involving equity investors willing to disburse their commitments prior to any draw of the debt. This allows for banks to lend their funds at a later and less risky stage of the project. Also worthy of note, export credit agencies
can be involved when a significant amount of the project's equipment is procured from a specific foreign country or locally when the project's output is intended for export. Having the mandate to enhance their nation's exports, these agencies may provide credit support in various forms, be it financial guarantees, credit insurance, or direct or intermediary loans. The amount of that support will be tied to that of the facilitated exports, and these agencies tend to have specific demands on the way the project financing must be structured (including with respect to ratios such as the amount of debt to that of equity used for the project's financing).
But of course the circle always closes were it begins: bankability might rest above all on the track record of the project's sponsorsâ€¦ and the aptitude of the management they appoint.
Arranging feedstock procurement, EPC completion and production offtake in a manner that secures a project's cash-flow should bring its sponsors quite close to the finish line. Bankability issues are however as diverse as industrial ventures can be and must be assessed and addressed on a case by case basis, which renders this field of practice quite exciting.
- Project finance in theory and in practice, by Stefano Gatti 2nd edition, Academic Press
- Principles of Project Finance, by 2nd edition, E.R. Yescombe, Elsevier Science & Technology Books;