Financing of Downstream Projects in Oil & Gas Sector

National Conference on Project Finance Management for Energy Sector Project Finance Management for Energy Sector by UPES Dehradun

& ISPe India in 2010

Presented by Mr Girish Ghildiyal Chief Manager Finance, HPCL-Mittal Energy Ltd

FINANCING OF DOWNSTREAM PROJECTS IN OIL& GAS SECTOR

FINANCING OF DOWNSTREAM PROJECTS IN OIL& GAS SECTOR

Petroleum – Value Chain

Upstream Midstream Downstream

• Exploration & Production (E&P)

• Firms explore new hydrocarbon fields

• Discovered fields developed and petroleum produced

• Transportation of oil and natural gas

• Shipping • Pipelines• LNG Terminals

• Refinery processes crude oil to produce different products

• Petrochemical plants

• Polymers, Plastics and other products

KEY PARAMETERS FOR PROJECT EVALUATION

KEY CONSIDERATIONS- REFINING

− Location− Inland - for domestic consumption

− Proximity to demand centre− Inland Freight economics, refinery gate pricing formula ( TPP

etc.)

− Coastal –export oriented refineries/petrochemical complex − Proximity to demand centre & crude source

− Logistic − Inland refineries- crude & product pipelines, rail transport− Coastal refineries – Ports ( Capable of handling VLCC), SPM,

pipelines

− Feedstock and Product prices depend on global demand supply situation

KEY CONSIDERATIONS- REFINING

− Product Offtake − Inland refineries- Own marketing ( for OMCs/ refiners with

marketing capability) ; Tie-up / offtake agreement with marketing companies (for standalone refineries) is crucial

− Coastal refineries - Higher marketability( access to global market), hence lower offtake risk

− Complexity− Measured by Nelson Index− Allows production of value added petrochemical products− Processing of cheaper heavy crudes , light/ heavy crude

differential

− Long construction time - change in market dynamics, project costs

− Cost and Complexity of refinery is key in determining future profitability

KEY CONSIDERATIONS-PETROCHEMICALS

− Location− Proximity to demand centre − Naphtha, the major feedstock is a traded commodity and

obtained from refineries directly / imported− Proximity to other feedstock's like Gas ( c2-c3 )

− Logistic – proximity to port, roads, train ( Petrochemical products are solid/ liquid ); higher freight costs

− Product Offtake – − Lag between movement in feedstock prices and product

prices− tie-up with further downstream petrochemical units/

exporters/traders; − Market defined sale price ( vis-à-vis pricing formula for refinery

products)

KEY CONSIDERATIONS FOR FUNDING

FINANCIAL EVALUATION

Downstream projects

− Part of company (balance sheet funding)− Better pricing

− High management control

− SPV− Risk mitigation

− Other partners can provide additional expertise

Debt: Equity – − D:E of 60:40 preferred; Equity through promoter contribution/IPO/convertibles

etc.

− FDI upto 100 % in refining, 49% if along with PSU

Debt Service Coverage Ratio (DSCR) of around 1.5

GRM is analyzed as key parameter for profitability

Cost per refining capacity , complexity

Other incentives like VAT deferral, etc.

Capability of marketing partner to offtake products

Chart of Regional Refining Margins

Regional refining marginsUS dollars per barrel

BP Statistical Review of World Energy - 2009

LENDER CONSIDERATIONS

Sponsors experience and capability to bear market risk and cost overruns

Demonstrating marketing arrangement

Demonstrating market demand cost competitiveness of the products

Statutory and Regulatory approvals esp. w.r.t. land and environmental clearances

Credit strength and experience of project sponsors

Sponsor support undertakings

Creation and enforceability of security

Governance structures, information reporting and transparency

Project technology and experience/capability of executing contractors

Project operator’s technical expertise and credit strength

Product marketing arrangements and credit strength of offtaker

Price risk and hedging arrangements

Reliable transportation arrangement for feedstock and products

Financing is available for well structured projects oil & gas sector

Quality and credit strength of project participants is important

FUNDING OPTIONS

RUPEE FUNDING

Domestic currency

Easy availability in adequate volumes− Available even at initial stages of construction/planning

Flexibility in disbursements, covenants

Long tenor Financing available for well structured projects

Quality and credit strength of project participants is important

Pricing linked to PLR of lead bank, sub-PLR loans possible

Do not require compliance to equator principles

Allow flexibility in cancellation of loan without penalty− Refinancing through ECB/ ECA of undrawn portion

− Refinancing through internal accruals

EXTERNAL BORROWING (ECB)

Governed by regulations of FEMA, RBI

− Upto USD 500 mn p.a. can be raised under automatic route for meeting capital expenditure ; permission for additional amounts

− Ceiling on all in cost is LIBOR + 500 bps

Revenues in USD, most capital imports in USD; hence natural hedge for currency

Lower all-in pricing ( due to saving of hedging cost) for refineries

Interest rates linked to LIBOR

− Lower interest rates compared to rupee loans

− Option to convert to fixed rate through derivatives

Tenors of upto 12 years also available

Not as flexible as domestic lenders regarding covenants, prepayment

In case of SPV funding , ECB available only when project is nearing completion

Factors deciding pricing

− Sovereign rating

− Withholding tax

ECA Finance – Essentials

Most OECD countries have a government sponsored Export Credit Agency (“ECA”) to support their export of capital goods

ECAs provide insurance cover/guarantees to lending banks to mitigate both political and commercial risk entailed in export transactions

Commercial banks structure cost-effective financing packages against ECA cover

OECD Consensus guidelines dictate inter alia that ECAs may provide cover:

− For up to 85% of the value of the eligible goods / services being exported from the country concerned; and

− Local costs may be financed up to a value of 15% of the export content

ECAs charge a premium for providing cover

Fixed rate financing is available (Commercial Interest Reference Rate)

Some ECAs provide direct lending

EXPORT CREDIT AGENCY ( ECA)

Government sponsored Export Credit Agency (ECA)- support the export of capital goods and services

Funding amount is function of the actual sourcing from the country of the ECA, hence country specific

ECA financing is largely insulated from market volatility compared to ECB

Interest rate options – Both fixed and floating rate options available with most ECAs

Withholding Tax exemption in most cases

Credit enhancement

− ECAs extend guarantees representing a sovereign risk against which commercial banks structure financing packages. Guarantees are provided in return for the payment of a premium charge

− commercial banks can bundle funding from multiple ECA’s , where sourcing of equipment is from multiple countries

ECA’s funding visi-a-vis ECB

− Lower interest rates

− amount not a constraint

− longer tenors

− Tedious process for availing loan ( ~ 6-12 months)

− High upfront payment, hence pre-payment not a good option

EXPORT CREDIT AGENCY ( ECA)

Japan

United States

France

United Kingdom Italy

Canada

Germany Denmark

KEXIM/KEIC

ChinaPremium

Commercial

Contract

Borrower

Exporter ECAs

Lender

Drawings for Contract Payment

Principal Repayment & Interest

Guarantee / Support Agreement

Goods & Services

Loan Agreement

Application Documentation

DEBT FUNDING OPTIONS- COMPARISON

Instrument/Feature RTL* ECB ECA

Availability Normal High Credit Rating Cos.

Country Specific

Tenor (years) 10-14 5-7 8-12

Interest Rate Basis PLR LIBOR LIBOR

Hedging Cost - High High

Commitment Fee Nominal High High

Flexibility in Drawdown High Low Low

Typical Tie-up time 3-6 months 3-6 months 6 -12 months

OTHER SOURCES

Notes/ Bonds − Domestic & Foreign currency

− Various options like Zero coupon, deferred coupon, convertibles etc

− Usually available at advanced stages of construction for SPV

Project company IPO ( eg. Reliance Petroleum)

OIDB (Oil Industry Development Board) funding− Interest rates linked to G-Secs

− Tenors of upto 10 years at low interest rates

− Disbursement mechanism governed by

− OIDB loans to non-Navratna Oil Companies and Joint Ventures Companies, interest rates on case to case basis

RISK MITIGATION

Type of Risk Risk Allocated to Mitigation Metric

Management Risk

- Operating Risk

- Withdrawal

Sponsor

Sponsor

Experience/O&M contractor

ND Undertakings

Pre-completion Risks

- Land Availability

- Time Overrun

- Cost Overrun

- Funding

Project Co/Govt.

EPC Contractor

EPC Contractor

Sponsor

Notification/Sale Deeds/Lease

Fixed time, Fixed Price contracts

Equity & Debt Agreements

Post-completion Risks

- Feedstock Supply

- Feedstock Tpt.

- Environmental

- Plant Availability

- Evacuation

Feed Supplier/Project Co.

Supplier/Transporter

Project Co.

O&M contractor

Project Co./Off-taker

LD Provisions/Alternate sources

LD Provisions

Requisite Approvals

Penalties

LD Provisions

RISK MITIGATION

Type of Risk Party Mitigation Metric

Market Risks

-Off-take

- Payment.

Project Co./Off-taker

Off-taker/Guarantor

Suitable agreements

Credit Enhancement

Technology

- Availability

- Facility Design & Performance

- Damage

EPC Contractor

EPC Contractor

Project Co.

Continuing Support

Guarantee, Warranty

Insurance

Financial

- Interest Rate

- Inflation

- Fx Fluctuation

Project Co.

Project Co.

Project Co.

Continuing Support

Guarantee, Warranty

Insurance

Force Majeure Project Co. Insurances

Back to back clauses of Agreements

Project Financing

What is PEF?

Project Finance is financing to an existing company or a newly formed entity wherein lenders are satisfied with:

− the cash flow projections as the primary source of repayment, and

− the specific project assets (fixed assets, contracts) providing collateral for the loan

A successful project financing is viewed:

− by the client, as a financing structured with limited recourse to the sponsors and,

− By the lenders, as having sufficient credit support through the financing structure and/or sponsors’ undertakings.

Project finance transactions could include major expansions of existing facilities or refinancing of existing term loans.

Supply risk Market risk

Availability, sourcing and transportation strategy/

flexibility Waterflow risk

Demand/ supply situation Guaranteed offtake Price, demand, taxes

Independent review

Market demand Project cost

Environmental issues

Construction risk Technical risk

Infrastructure & Utilities

EPC/ Project Management approach Contractor (top tier) LD (delays/ cost)

Guaranteed operational parameters

Technology vendor, use of proven technology Proven design

Train/ unit configuration Adaptibility to local

conditions

Access Roads Logistics (port,

evacuation) Water (Environmental

impact) Land (Social impact)

Project Risks

Pre-completion Post-completion

Equity commitment/ adequacy of internal

accruals Shortfall in raising up

Debt Cost overrun support Debt-service due to

delay in startup

Stabilisation of project parameters

Plant Management

Financing & Syndication

Robust Capital structure Liquidity and credit

appetite Shareholding and

management control

Sponsor support

Project Financing

Typical Covenants

Financial Covenants

• Debt Service Cover Ratio (DSCR)

• Loan Life Cover Ratio (LLCR)

• Maximum Debt/ Equity

• Debt to EBITDA

• Asset Cover Ratio

• Completion tests (for release of completion guarantees)

Other Covenants

• Draw-Stop provisions

• Restrictions on sale of sponsor equity without prior approval of lenders

• No modification of key contracts

• Non-disposal of assets

• Restrictions on nature of investments

• Restrictions on additional debt

• All environmental approvals to be kept current

• Material Adverse Change

• Reporting requirements

Typical Sponsor Obligations

Part funding of sponsor equity, prior to debt being drawn down; subsequently, pro-rate drawdown of debt and equity

Cost overruns to be financed through either

− Sponsor guarantees, or

− Standby Letter of Credit

− Standby sponsor equity + standby senior debt

EPC wraps, in the event that this is not adequately covered through the EPC contract (levels of Liquidated Damages)

Subordination of any sponsor debt, until senior project debt has been repaid

Dividend restrictions

− Dividends to be paid on a pre-agreed basis, subject to, inter alia

− Fully funded DSRA

− No covenant default

− No default on debt service

THANK YOU