Introduction to Project Finance March 29, 2011 Andreas Back Wärtsilä Development & Financial Services Program – Project Finance Module I - IV 29.3.2011 • Module I: What is Project Finance? • Module II: Introduction to the Liberty Project and its Financial Model (Case study, Lauri Puro) • Module III: Risk Allocation & Mitigation The Sponsor/Borrower Perspective • Module IV: Getting towards the Finish Line The Lender’s Perspective 5.4.2011 This is Andreas Back 2001-2005 2004-2007 Pakistan 2009 Liberty 196 MW Brazil 2008 Viana 176 MW Southeast Asia 2010 - 2011 -Bangladesh -Indonesia This is Wärtsilä SHIP POWER POWER PLANTS SERVICES 4 © Wärtsilä Cozumel Update / By: Alejandro Bastardo Our offering … we are seeking growth beyond the organic growth NON-ENGINE RELATED SERVICES Ship services Power Plants OEM services Engines Propulsors ADDITIONAL PRODUCTS Ship Power systems O&M Competitors’ engines ADDITIONAL ENGINE BRANDS This is Wärtsilä Development & Financial Services WDFS Scope of Services WDFS is a global customer financing and project development function within Wärtsilä Corporation WDFS has 18 professionals based in Helsinki, Vaasa, Houston, New Delhi, Annapolis, Zwolle, Trieste, Paris, Dubai and Rio de Janeiro Offering includes; ECA financing and export guarantees IPP project development Structuring of commercial bank funding Feasibility studies and Financial analyses modelling services Carbon credit consulting Utilisation of development banks and funds Module I: Project Finance What is Project Finance? …and the Impact of the Financial Crisis… Definition Defined by the International Project Finance Association (IPFA) as the following: The financing of long-term infrastructure, industrial projects and public services based upon a nonrecourse or limited recourse financial structure where project debt and equity used to finance the project are paid back from the cash flow generated by the project. Non-recourse: the sponsor has no obligation to make payments on the project loan if revenues generated by the project are insufficient to cover the principal and interest payments on the loan What is Project Finance? • The financing is not primarily dependent upon the credit support of the sponsors or their balance sheets • Reliance instead is placed on performance of the project itself (i.e. project cash flows and assets without recourse to the sponsors) • Risks are allocated to the party best able to manage the risk heavy documentation • Project Finance is not a mechanism of financing “non bankable” projects Why Project Finance? Advantages No recourse to owners Off balance sheet accounting treatment Risk sharing optimization Political risk mitigation Drawbacks Extensive development time schedules Lenders advisors => increased development cost Increased insurance cover Cost of on-going monitoring (technical progress and performance) High(er) lenders’ fees Potential interference by lenders Transfer restrictions by lenders Project Finance in a Historical Perspective • Railways, highways, other infrastructure • Co-Generation in USA in the 70’ies • Eurotunnel • Euro Disney • Large Power / Energy Projects • Oil / Gas and pipeline Projects • Toll roads and bridges • Panama Canal Project Finance vs. Trade Finance In a Trade Finance: • No separate “economical” unit • Borrower normally an established company • Cash flow not securing the credit • But securities like • Bank or corporate guarantees • Maturities are shorter • Trade financing serves the needs of one particular export Principles of Project Finance • There is no customized way to structure Project Finance Deals – Tailor-made legal, tax, security and financing solutions • Principles when structuring a Project Financing – Reach optimal compromise so that there is no recourse to the sponsors and but nevertheless sufficient undertakings by sponsors and other parties to satisfy the lenders – Each party should accept carry the risk over which it has most control • Main focus when structuring a Project Finance: Who carries the different risks??? – legal – technical – operating and management – environment – supply / market / off-taker – political “Procedures” in a Project Finance transaction • Feasibility Study – technical – marketing: need for the products provided – economic: future level of cash flow generated • Financial Proforma • Financial Plan – Evaluation of the best (available) sources of funding – Local commercial banks, ECA, IFC, DFI’s… • Structure the security package – Risk sharing between the different parties – Negotiate the project agreements • Arrange the funding – Lead Arranger – Negotiate the loan agreements Main criteria for Project Finance • Predictability of future cash flows – market situation and competitiveness – sensitivity analysis / cash flow model / Financial Proforma • Adequate collateral – equipment, pledges on shares • Satisfactory risk sharing – development, construction, operation • Acceptable country risk – political, economic, regulatory Analysis of market situation and competitiveness • Market situation and future prospects • Competitive advantage – technology being used – marketing and sales strategy – is the deal ”in the money”?? • Management and contracting parties – technical expertise brought by sponsors / suppliers – qualification and experience of operator (management) Doing Business Globally: relaxed airports Doing Business Globally: sometimes, flights are late… Project Economics / Sensitivity analysis • Economics of the project – CapEx – fixed and variable cost – income • Pricing – protection against inflation rate and currency volatility • Sensitivity to major parameters – sales price / electricity tariffs – cost of raw materials / fuel – cost of transportation – interest rates / loan tenors – currency exchange rate fluctuations Adequate Collateral • Equipment – possibilities to pledge and the value of pledge – secondary market value of equipment • Pledge shares in the project company – ability to take over management control and ownership • Project Agreements – Assignment of all project agreements and all tangible and intangible assets of the SPC • Guarantees – Sovereign Guarantee – Performance Bonds from suppliers – L/C from off taker Satisfactory Risk Sharing • Construction – sharing of risks and responsibilities between the sponsors, equipment suppliers and construction companies – technical failure, capital cost overrun, delays • Operation – supply of raw materials – supply of services – taxation, regulatory environment • Sales – Pricing (indexation) – Transportation / distribution – Currency repatriation Acceptable Country Risk • Political Stability • Limited risk of government interference in the project – Terrorism • a new kind of political risk • Regulatory framework in place • Economic situation and future outlook • Ability to convert to foreign currency Analysis of project viability • Technical feasibility – project construction cost, time schedule etc. • Economic viability – supply / demand situation – adequacy of raw material supplies • Creditworthiness – credit derived from the value of project assets and the underlying agreements – expected long-term profitability of the project – amount of equity project sponsors have at risk – credit support from pledges and guarantees by counter-parties • Assessing project risks – completion risk – technology risk – raw material risk – long term supply / demand situation Doing Business Globally: efficient transportation… Doing Business Globally: A Wonderful Experience Preparing the Financing Plan • Ensuring the availability of sufficient funds to complete the project • Securing the funding at the lowest cost • Minimizing the project sponsors’ credit exposure to the project • Dividend policy / annual coverage tests • Tax benefits / withholding taxes on interest ...some more considerations… • Amount of external funds required • Pre-commitments of all funds • Separate construction financing or directly to longterm financing? • Most feasible debt/equity ratio… • Timing of draw-downs • Expected project cash flow profile • Currency profile of project revenues and costs • Currency of the equipment supply contracts for the project Typical Structure of a Project Financed Power Project IA / Sovereign guarantee Off-taker Operating & Maintenance Agreement Power Purchase Agreement Sponsors / Shareholders Equity Operator SPV ”Power Inc.” Senior Debt Financing Turnkey Construction Contract Construction Contractor Fuel Supply Agreement Fuel Supply Company Banks Wärtsilä Development & Financial Services Conclusion There are no magic tricks to finance a power project! Impact of the Financial Turmoil to the Power Business It is though to be a banker today… Impact on Wärtsiläs business • Ship Power; ship financing became tighter or more or less seized to function – Increase in cancellations and delays – Impact on Wärtsilä quite substantial • Power Plants; impact of crisis not as severe – Fundamentals remain unchanged – Offering activity remains high – Bad projects would not get financed anyway… Impact hard to predict…but, electricity generation always increasing…(?) Case Study of Liberty Power Tech Ltd. Questions? Comments? “O.K., O.K., we get the point.” (Executive at a meeting