The Chad-Cameroon Petroleum Development and Pipeline Project
The Chad-Cameroon Petroleum Development and Pipeline Project Professor Doug Cerf Donald Bren Graduate School of Environmental Science and Management Environmental Risk Management (ESM 286) Winter 2008 What has been accomplished by the Chad Cameroon Project? • Very interesting consortium of parties to accomplish – – – – – – Economic development in a developing country Shared financial returns Sharing of risks Poverty alleviation Project development with concern for sustainable development Partnership of Governments, Private Corporations, Private Banks and The World Bank • How much risk is acceptable in economic development situations that have severe environmental and social issues? Printed on recycled paper-actually better, not printed at all How did the financing differ? • Review Corporate Structure in Exhibit 3a • Review Sources / Uses of Cash Exhibit 3b • Field System – Oil wells and drilling equipment • Export System – Pipeline and off-shore loading system Printed on recycled paper-actually better, not printed at all Corporate Finance for the Field System • No debt all equity • 3 sponsors (upstream consortium) • Exxon/Mobil exposure 608m – 40% of $1,521m – Market value of equity $280b • High discretion over cash flows • Monitoring is done internally – As opposed to the external monitoring similar to the equator principles Printed on recycled paper-actually better, not printed at all Equator Principles • A new voluntary framework to guide “project financing” decisions • Endorsed in 2003 by ten leading banks • Non government organizations (NGO) wanted financers of large projects to take legal and moral responsibility for the social and environmental impact on local communities and host nations caused by the projects that they financed Printed on recycled paper-actually better, not printed at all Project Finance • Project finance involves the use of limited or fully non-recourse debt by a corporate partner (the sponsor or sponsors) to finance investment in and ownership of a legally independent, single purpose industrial asset usually with a limited life. Printed on recycled paper-actually better, not printed at all Key elements of the project finance agreement • Key elements: – An investment in an industrial asset – An organizational decision to create a new, legallyindependent entity – Financing decision involving non-recourse debt • The project financing arrangement is limited non-recourse debt because it provides a guarantee for debt repayment through completion • After completion there is no recourse to sponsors • The debt is an obligation of the project companies, Techad (TOTCO) and Cameroon (COTCO) pipeline projects • Repayment is a function of project cash flows Printed on recycled paper-actually better, not printed at all Key elements of the project finance agreement • By creating a legally-independent entity the borrowing entities (the sponsors) are able to protect their balance sheets – Off balance sheet financing – Exxon/Mobil has a debt to equity capital ratio on its balance sheet of 23% – Export system debt to equity ratio is 62-64% – Would Exxon/Mobil do this deal on their balance sheet? Printed on recycled paper-actually better, not printed at all Exxon Review • Look on Google finance to determine: – Total Market capitalization – Balance sheet debt and equity Printed on recycled paper-actually better, not printed at all Risk Management • Reason for using project finance – Risk sharing and risk mitigation • Risk sharing – Lead sponsor Exxon/Mobil brought in other sponsors (Chevron and Petronas) – Diversified borrowing through banks, bond holders and the World Bank Printed on recycled paper-actually better, not printed at all Risk Mitigation • Risk mitigation – Inclusion of the World Bank /IFC to help mitigate political and reputation risk – The world bank .. • as the lender of last resort for impoverished countries the World Bank has leverage over these countries that private sponsors do not have. • has the experience and technology to deal with environmental, social and political risk that is superior to that of a private sponsor • the world bank can sort through the propaganda to determine the actual behavior on environmental and social issues Printed on recycled paper-actually better, not printed at all How much risk mitigation is needed? • How much involvement by the world bank is needed to get the risk mitigation benefits that Exxon/Mobil (sponsors) are looking for? • Generally, for highly rated companies like Exxon/Mobil project finance is more expensive than corporate finance – The extra costs are in the costs to structure and fund the project finance ($15 million of preparation costs) • See quote under financial projections on page 3 of case Printed on recycled paper-actually better, not printed at all The World Bank’s role • Sponsors want World Bank involvement for risk mitigation • The world bank is primarily interested in – Poverty alleviation – Sustainable economic development – There is no better place than Chad for poverty alleviation • The World Bank has the expertise to understand and impact the risk issues – Corporate sponsors could not take on a project with these risks because they do not have this expertise • The World Bank loans to projects it does not loan to companies. Printed on recycled paper-actually better, not printed at all The World Bank’s role • World Bank Group played four key roles – It appraised the project for sponsors and other outside lenders to uncover important information • It assisted with the environmental assessment – It structured the project to ensure “fairness” and to minimize social and environmental impact • Policy advice to ensure long term sustainability – It made direct investments and mobilized other funding sources – Deter government interference Printed on recycled paper-actually better, not printed at all Is this deal fair to Chad? • • • • Investment of capital is very low $47 million Equity investment is funded by loans Chad is using up one of its only natural resources Net present value (Low/High scenarios from Table 5) – Low expected oil price and low volume: $108 million – High expected oil price and high volume $1,170 million – Expected value $463 million • Internal Rate of return – Relatively low investment therefore IRRs are high – Low 42% – High 90% • • Chad makes more than the private sponsors in all of the low volume/low price scenarios Chad has the greatest downside risk protection Printed on recycled paper-actually better, not printed at all Is this deal fair to Cameroon? • • • • Equity investment in pipeline project Returns are essentially invariant to the price of oil It is most sensitive to volume changes Net present value (Low/High scenarios from Table 5) – Low expected oil price and low volume: $92 million – High expected oil price and high volume $156 million • Internal Rate of return – Relatively low investment therefore IRRs are high – Low 34% – High 40% • Much less variation than for Chad Printed on recycled paper-actually better, not printed at all Is this deal fair to Private Sponsors? • Very sensitive to the change in oil price and volume • Net present value (Low/High scenarios Table 5) – Low expected oil price and low volume: $(917) million – High expected oil price and high volume $1,614 million • Internal Rate of return – Low less than zero% – High 27% • The largest upside in dollar return Printed on recycled paper-actually better, not printed at all Fairness and the distribution of project returns • Timing of the returns – Chad, Cameroon and private sponsors get 29.2%, 51.4% and 56.3% of its undiscounted cash flows respectively in the first 10 years • Chad’s receipts are back-loaded to protect against sovereign interference • This approach may be inappropriate given Chad’s needs to alleviate poverty • Chad is assuming reserve risk – Proven reserves last through year nine – If probable and possible reserves do not materialize then Chad suffers Printed on recycled paper-actually better, not printed at all Fairness and the distribution of project returns • Division of the returns – Total $1.78 billion – Chad, Cameroon and private sponsors get 22%, 6.6% and 71.4% of the total distributable cash flows – Looks pretty good for Chad based on the amount invested – Chad’s position is driven by their inability to raise external capital • If they could raise external capital would they have needed the private sponsors (Exxon/Mobil etc.)? • Cash flows would have tripled without the private sponsors (assumes inclusion of Cameroon) Printed on recycled paper-actually better, not printed at all Fairness and distribution of project risks • Construction risk – Construction risk is low • Sponsors know how to develop oil fields • They have certified variables related to the amount of reserves with independent consultants • Financial risks (excluding sovereign risk) – – – – – Low given the debt service reserve fund Debt service coverage ratio is 2.1% or higher Low finding and development costs of $5.20/barrel Risk of oil price fluctuations Risk of quality of the oil extracted Printed on recycled paper-actually better, not printed at all Fairness and distribution of project risks • Sovereign Risks – Political risk • Potential to disrupt the project • Dependent on the political situation in both Chad and Cameroon – Environmental and social risk fall on the host nations – Sponsors bear the environmental and social risk indirectly through reputation damage • Could be large has shown by Exxon Valdez Printed on recycled paper-actually better, not printed at all Is the sharing of the risks and returns fair? • Is World Bank involvement evidence of fairness? • Would you approve the deal as a World Bank/IFC board member? – Three slides follow on why the plan should be approved – Three slides follow on why the plan should not be approved • What are the alternatives? Printed on recycled paper-actually better, not printed at all Reasons for the World bank to approve the deal • Opportunity and need to alleviate poverty – Chad has few opportunities to alleviate poverty and spur economic development – Chad situation has deteriorated over the last decade – Chad situation is bad compared to other African nations • Opportunity to leverage $177 million from the World Bank for a $3.7 billion project (5% of the funding) • Commercially attractive project with conservative oil price and volume assumptions Printed on recycled paper-actually better, not printed at all Reasons for the World bank to approve the deal • In the view of some the project fairly allocates project risks and returns – Chad puts in very little and stands to pull out a lot • Social and environmental issues have been adequately addressed – 19 volumes of environmental assessment documents – Hundreds of meetings with experts, indigenous people and NGOs – Numerous contingency plans • The World Bank knows how to structure projects for success Printed on recycled paper-actually better, not printed at all Reasons for the World bank to approve the deal • The Revenue Management Plan will work – Future lending to Chad is contingent on the Revenue Management Plan – Built in auditing and oversight mechanisms Printed on recycled paper-actually better, not printed at all Reasons for the World bank to oppose the deal • Pipeline revenues may displace existing aid – Chad will have used up the natural resource and be in the same “aid” position – Current aid is $188 million per year – Expected project cash flows are about half during the main part of the project Printed on recycled paper-actually better, not printed at all Reasons for the World bank to oppose the deal • Key participants have troublesome records – Exxon/Mobil • Exxon Valdez • Chairman spoke against strict environmental standards in developing countries – The World Bank • Has not been successful structuring deals to manage oil booms • Revenue Management Plan is an experiment – Chad and President Deby • Civil war has stopped economic development on several occasions in the past • has a poor record on human rights • Can not be trusted to implement the revenue management plan Printed on recycled paper-actually better, not printed at all Reasons for the World bank to oppose the deal • Revenue management plan has serious flaws – Lacks specificity • Does not provide detailed expenditure guidelines – Lacks effective oversight mechanisms • Is the oversight committee unbiased? • Is the money that goes to the Chadian banks guaranteed to be used for the appropriate purpose? – Lacks credible enforcement mechanisms • No subpoena power or investigatory powers Printed on recycled paper-actually better, not printed at all Reasons for the World bank to oppose the deal • Revenue management plan has serious flaws (continued) – Represents an invasion of sovereign rights • Chad owns the oil reserves and should be allowed to spend the country’s wealth as it sees fit • Analogy: few employees would agree to employment contracts that dictated how they should spend their disposable income – Portion of funding to alleviate poverty is not enough • Portion of cash for restricted investment is 60% over the life of the project • Chad receives the bulk of its returns in later years in the form of upstream taxes – These flows are not subject to oversight and control Printed on recycled paper-actually better, not printed at all Reasons for the World bank to oppose the deal • Revenue management plan has serious flaws (continued) – Environmental and Social risks are excessive – Distribution of project returns is not fair • Chad’s returns are in distant years • Chad’s returns may not materialize if “probable reserves” do not materialize • Chad needs poverty alleviation now – Commercial viability • How high can the discount rate go before the NPV’s turn negative Printed on recycled paper-actually better, not printed at all What has been accomplished by the Chad Cameroon Project? • Very interesting consortium of parties to accomplish – – – – – – Economic development in a developing country Shared financial returns Sharing of risks Poverty alleviation Project development with concern for sustainable development Partnership of Governments, Private Corporations, Private Banks and The World Bank • How much risk is acceptable in economic development situations that have severe environmental and social issues? Printed on recycled paper-actually better, not printed at all Case questions • • How are the sponsors financing this deal? How does the financing of the Field System differ from the financing of the Export System? What is the World Bank/IFC’s role in this deal? Are they likely to be successful? Printed on recycled paper-actually better, not printed at all Case questions • Analyze the risks and the returns to Chad, Cameroon, and the Private Sponsors. How were the returns calculated? Are the risks and the returns fair from each party’s perspective? • Will the Revenue Management Plan work? Are there aspects of the plan that you think should be changed? • Would you approve the deal as a World Bank/IFC board member? Printed on recycled paper-actually better, not printed at all
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