Project finance principles

The following articles relate to project finance principles. They can be read sequentially, or individually, as you require.

If you have any queries or comments, please email me at doug@verdigris.co.za, or leave a comment in the comments section in the relevant article.

Project Finance Principles

Infrastructure projects Project finance loans are typically used to fund infrastructure projects. Examples of infrastructure projects include: Power plants, Water plants,

Non-recourse lending

Project finance loans are typically non-recourse or partial-recourse. This is effected by setting up a Special Purpose Vehicle (SPV) which

Cash flow lending

Project finance loans are typically made against the future cash flows of the project, rather than against the assets of

Intensive due diligence

Because projects are typically technical in nature, project finance lenders rely heavily on advisors. A typical project finance transaction will

Risk pass through – counterparties

Projects using project finance will seek to pass as much risk as possible to other project counterparties. These project counterparties

Offtakers

The offtaker for a project is the counterparty, or counterparties, which purchase the output of the project. The creditworthiness and

Single offtakers

Projects will need to have a revenue stream which is estimable in advance with a high degree of certainty. This

Multiple offtakers

A project may also have a multiple offtaker business model. If this is the case, the project will need to

Provisions found in offtake contracts

Offtake contracts (particularly single-offtaker contracts) will typically contain provisions relating to the following: Price and price escalation Minimum supply obligations

Engineering, Procurement and Construction

Projects will typically sign an EPC contract with a single counterparty, which will be tasked with delivering the full project

Risk pass through to EPC Contractors

As discussed on the Project Finance Principles page, the Project will attempt to pass as much risk through to the

Provisions found in EPC contracts

EPC contracts will typically contain provisions relating to the following: Price and milestone payment schedule Scope of work, usually including

Operations & Maintenance

Projects will typically sign an Operations and Maintenance contract with a single counterparty, which will be tasked with operating the

Risk pass through to the Operator

Similarly to under the EPC arrangements, the Project will attempt to pass as much risk through to the Operator as

Provisions found in O&M contracts

O&M contracts will typically contain provisions relating to the following: Price and price escalation Scope of work, detailing the Operator’s

Supply contracts

Projects will often, but not always, have one or more supply contracts. Supply contracts are those for major items which

Risk pass through to suppliers

Similarly to under the EPC and O&M arrangements, the Project will attempt to pass as much risk through to the

Provisions found in supply contracts

Supply contracts will typically contain provisions relating to the following: Price and price escalation Take-or-pay provisions. I.e. how much the

Asset classes used within infrastructure finance

There are four main asset classes commonly used within the Infrastructure Asset Class, not accounting for hybridisation, being: Equity Non-recourse

Equity

Project finance debt providers will seldom allow the project to be funded by debt. Consequently the project will almost always

Non-recourse debt

This is debt advanced on traditional Project Finance principles: Lent against projected cash flows; Either pre-contracted offtake arrangements with credit-worthy

Full-recourse debt

Full recourse or corporate debt differs from non-recourse debt in that it is the sponsor that borrows the funds, rather

Derivatives

Derivatives are used to hedge against uncertainty in macroeconomic factors influencing project cash flows, in particular interest rates, exchange rates,

A typical project finance term sheet

Equity injection style Up-front; or Pari-passu with debt; or Back-ended, subject to full acceleration rights and bank guarantees in

Project finance hedges

Project Finance hedges are typically vanilla interest rate- or fx swaps. Contractual protections are usually very similar to those of

Political Risk

One of the key risk areas considered by the banks when lending to an infrastructure project is country risk. This

Guarantees from counterparties

Different counterparties to the project may be required to provide guarantees that their performance will meet a certain minimum standard.

Renewable energy yield analysis

The energy yield assessment is a fundamental requirement for any new wind or solar project, with both developers and lenders

Is volatility in a renewable energy yield assessment good or bad for lenders?

BAD! Or, at least, that’s the general view. As always, however, there isn’t a simple answer. I once made a

Infrastructure Project Lifecycle

As a project moves through the project lifecycle, it increases in value and new funders are required to invest at

Valuing infrastructure projects

From time to time an infrastructure project or its shareholders may need to know the value of the project’s equity.