Project finance
Last week I had indicated that this week’s column would be devoted to the further elaboration of the financing structure of the Amaila Falls Hydro Project (AFHP). Since then, several readers familiar with the standard methods of corporate financing have correctly pointed out to me that, when businesses plan to develop new ventures, they would seek lenders (investors) mainly on the strength of their company’s reputation; balance sheets (for financial assurance); creditworthiness; and, soundness of the business proposal. The company would then either offer ownership (equity) in exchange for funding, or seek loans at a charge.
The AFHP’s financing is not structured along the lines of the standard business model. Instead it is structured along what is termed project finance lines. In recent decades this method of approach has been widely utilized worldwide to finance long-term infrastructural projects. Indeed about one-third of such projects have been dedicated to power generating facilities.
PPA and AFH Inc
As indicated last week, the AFHP’s long term financing is principally organized around the projected cash flow to the project, arising from its long-term sale of electricity to GPL through a Power Purchase Agreement, (PPA) between it and Amaila Falls Hydro (AFH) Inc.
More precisely, the AFH Inc is therefore a Special Purpose Vehicle/Entity (SPV/SPE) created by the project sponsors to carry the legal and operational responsibility for executing the project. To be able to do this AFH Inc is invested with the project’s assets. This legally ‘protects’ the other assets held by sponsors, in the event of project failure.
Further, this arrangement facilitates what is termed non-recourse, or at times, ‘limited recourse loans’ (that is, with sponsors’ surety) for financing the project. As pointed out, in this particular instance the equity and debt put into the project are secured by the cash flow to the project (generated through the PPA with GPL). In standard business financing models the practice is for debt and equity to be secured through the ‘profitability’ of the business venture, as reflected in the company’s balance sheet. Some private firms, like the Sithe Global Group and the notorious Enron Corporation before it, are attracted to these arrangements because they allow projects to be funded off-balance sheet!
Observations
Several pertinent observations are warranted at this stage. First, readers should entertain no illusions about the intended purpose of AFH Inc. This is readily gleaned from the alternate term the financial literature uses to describe an SPV; that is, a “bankruptcy remote entity.” Thus a subsidiary of the Sithe Global Group, AFH Inc, insulates the parent Group from financial risks, even as it also makes the project’s assets secure from bankruptcy and similar untoward developments within the Sithe Global Group.
Second, PPA’s are often termed Off-Taker Agreements. In the case of the AFHP several key items are expected to be covered through this agreement including 1) the project’s debt obligations; 2) its operating costs; and 3) providing the agreed rate of return to the various project sponsors. However, the projected revenue flow is therefore largely contingent on the price and volume of electricity sold by AFH Inc to GPL, and, in turn, GPL’s ability to foot the bill.
Strictly speaking though, the project’s cash flow is secured by all of the project’s assets and its revenue-producing contracts. Lenders to the project would be given liens on these assets that would legally allow them to take over the SPV if it does not comply with the terms and other conditions for the loans it receives. As previously noted, the IDB and the CDB have been legally designated Senior Lenders to the project.
Third, similar to other project finance arrangements, the AFHP has contractors (two of them) responsible for the Engineering, Procurement and Construction (EPC) works in the project. These EPC contracts are with the China Railway First Group and the Government of Guyana (GoG). The former covers the construction of the hydropower facility and its electrical interconnection (to pre-determined specifications and performance criteria). This accounts for the bulk of the upfront capital outlays under the project. The cost of this Contract however, would change, if there are further delays in Project completion. Thus the most recent press release on this matter issued by the Sithe Global Group, reports that the cost under this contract had already risen by about 18 per cent since 2009, on account of several factors, including increases in commodity prices and construction costs; debt charges; and, appreciation of the yuan. The GoG has sub-contracted out the construction of the access roads of the project (211 kilometres) but remains directly responsible for their maintenance. This has already more than doubled in cost, due to project delays.
Finally, over the years project finance arrangements have increasingly involved partnerships between private investors and the public sector (PPPs). These PPPs have attracted both multilateral financial institutions (like the IDB in the case of the AFHP) and major national developmental financial institutions (like the China Development Bank) to become involved in them.
Financial ratios
In conclusion two points are worth considering. First, the financial literature treats project financing models as being more complicated than standard business ones. This may be because they involve more elaborate financial modelling, through which project risks are identified, allocated among the project sponsors, and guarded against, as constituent elements of the project’s ‘delivery methods.’
Second, because of the critical role GPL plays in the project’s financing structure, this has enormous implications for government’s liabilities under the project. This will be pursued further in coming weeks. For now, it should be noted that the GoG is implicitly and explicitly the premier guarantor for the project. This is crucial in evaluating the project, particularly as the capital cost:financing cost ratio for such projects is typically about 80:20, while their debt to equity ratio is about 70:30.
