The Road Map for Investment in New Refinery Projects Supporting Investments in Iraq- Opportunities and Challenges By:- Dr.Husain Al-Chalabi [ FEI ] Petroleum.

The Road Map for Investment in New Refinery Projects

Supporting Investments in Iraq-Opportunities

and Challenges

By:- Dr.Husain Al-Chalabi [ FEI ]Petroleum Consultant Tel:- 00447951396132

18 April 2012

Content 1. The Need for New Refineries

2. New Refinery project - Characteristics

3. Investment needed

4. Investor’s considerations

5. Choice of Investor / partnership

6. Funding of projects

7. Concluding Remarks

1. The Need for New Refineries

• As long as demand for crude oil is on the increase, Refineries are needed especially in Developing Countries . However , revamp and upgrade of existing sites takes the priority .

• Refineries will be built , where there is net gain [ economically ; socially ; strategically , skill development, etc….] .

• The background of the Equity holders in Refineries will depend on the relativity of the “net gain elements” in the mix.

2. New Refinery project - Characteristics

• Location :- – Market – Features and size of the location– Raw material supply – Environmental Impact – Infrastructure – Support facilities , resources and supplies

• Typical period of time to implement the project [ from concept to commissioning ]:- – Best recent record is Reliance Industries Ltd 33 months for the first refinery and 36 months for the

second refinery– Recent refineries in China , US , Saudi Arabia , Vietnam have taken 5-10 years [ source:-

Reliance ] .• Basis for project conceptualisation & evaluation :-

– The “Concept phase” of a refinery project is based on the knowledge of today & the events of the past and prediction [ and / or vision ] of the future .

– Prediction accuracy reduces the further the projection. – The Asset will be designed for the projected availability of the crude oils & their quantities and the

quality of the various products. Often the “value” of phasing [ dynamics of organic growth ] the investment is overlooked.

– The accuracy of the project cost is better known [ especially with a lump sum EPC ], than the revenue stream.

– The project revenue is derived from the operation of the refinery and the sales of products , which is about 4-5 years from the conceptualisation of the project, hence carries relatively high uncertainty . Fortunately there is a trend in “refining margins” , which is more important for the cash flow than revenue from sales .

2. Cont…

Refinery Project - Development Criteria:

• Value Addition [ Moving Up or down the Supply Chain ]

• Harmonisation with the Overall Economic Development Plan

• Refinery Project as pillar to Industrialisation & Development [ upward or downward “market integration” ]

Typical Supply Chain

Crude Oil

Retail Markets

IHRDC

Harmonisation with the Overall Economic Development Plan [EDP]

• Multi Industrial projects Integration Concept and its benefits

• Just in time phasing

• Development of Skills and Resources

• Outside the boundary:- Infrastructure and Support Services

Remember:- [ EDP] is structured to:- Synergise & integrate projects in all sectors in a multiphase plan; includes ORGANIC growth over time; Guided by long-termVision; flexible to re-examine progress and alignment with emerging needs.

Competitiveness

Products Costs:-• key characteristics of more economical products

costs:-– Highly efficient project technology compared to

current and potential alternatives.– Site advantage.– Pricing protection against volatility– Sound financing , raw material supply or operating

strategies– Proximity to secure raw material supply.

Balancing Act for Success

A Small Refinery - 31,000 B/DNear Great Salt Lake - Utah / USA

O&GJ

3. Investment NeededInvestment = Project Cost + other costs

Project Cost [ Estimated Erected Cost - within the refinery fence ] = Design and Construction [ Material & labour ].

Other Costs = owner’s cost , cost of capital , insurance , land ,working capital , spare parts , etc…

Factors impacting Investment :- 1. Capacity2. Complexity & products yields 3. Quality of raw material & products 4. Environmental compliance 5. Provision of common facilities [ provided by others ]

Factors impacting Construction Cost :- - location factor - Infrastructure support - Local content [ support industries and skilled labour ]

Approximate current investment for high complexity refinery with 200-250 KB/D in a developing country is 4-7 billion USD

O&GJRefinery Complexity

SWEC

Stages for Capital Projects

SWEC

Funding

Development of Project Plan & Scope

3. Example: Refineries as “Value Addition” Projects

• Refineries should be evaluated as an investment project. Hence, the following criteria / factors need to be considered ,for economic viability and sustainability:-– Secured Market for the products [ e.g . off-take agreement ]

– Products yield & value

– Crude oil availability [ quality & volume ] & its cost

– Configuration / structure and potential phasing of investment

– Technology & operating risk

– Construction delays and/or issues arising.

– Off-taker credit strength

– Projected financial results of the project

– Flexibility & sustainability of the operation with projected changes feed stock & in product slate and/ or specifications

– Harmonisation with the overall economic development plan

3. Do you Need Funding or Investors ?

• For the project to meet its planned objectives, the Sponsor will identify [during the course of the project definition] whether Funding is needed and/or a partner that can “add value” to the project

• During the application of stress testing the resilience of the project, forming an alliance [ or payment for services] may not mitigate the risk, a partner / investor could be the answer

Note:-

• The Need for Funding:- The process secures that the cash flow is acceptable till the loans are fully paid

• The Need for Investors/ partners: The process secures that the cash flow & sustainability is acceptable throughout the life cycle of the project

3. Need for External Resources

• Governments may not have:

- Capacity to finance

- Cost effective resources

- Ability and skill to develop, implement, or operate

- Resources to focus on sustainability

3. Selection of Business Structure Model

• Once you confirm the need for External Sourcing, you evaluate options for the functionality & sustainability of the project [Stress testing]

• If securing investor [with the right qualifications] mitigate the concerns, you translate the partnership into a Business Model

• Relationships & responsibilities are established by negotiated Agreements

Note :- Agreements are negotiated . It is often overlooked that : “ You get what was negotiated & not what your worth is” Lessons Learnt:- Enrich your negotiating team with compatible skill to that of the other party to achieve longer lasting relationship

4. Investor’s considerations

4. What are the Preliminaries before you think of Project Funding or Investors ?

• Do you have suitable business plan ?

• Is the plan backed with credible “Bankable Detailed Feasibility Study” ?

• Are you looking for Project Finance or Borrowing against Sovereign Guarantees?

• If you are looking for Project Finance, What is your project ?

If You have a good project , and market it effectively, Funding is not a challenge

4.Sources of Uncertainty

• Try to capture both the project and the wider implication.

• If project definition is low [and uncertainty is high], it is important to identify upfront what should be done to mitigate the risk.

• This requires a “road map” with the record of actions to mitigate risks and provide response without delay as well as transparency of the process.

4. Typical Subjects in the Business Plan

• There is no standard format but most plans include:• An executive summary highlighting the main points - Details of key personnel with

an organisational chart showing individual responsibilities.• Market research - details of competitors and how the project fits into the market - eg

who are the potential customers are and why you think they will buy your product or service.

• Your marketing plan - how you are going to get your products to the potential customers, together with any assumptions made when setting your targets.

• Financial information – eg. key ratios. These can be used to compare your business' performance against industry benchmarks. How you will manage credit, expenditure, stock planning and control, and debtors and creditors.

• When seeking funding, include:• A cash flow forecast indicating the amount of funding you need and why. For a start-

up, include estimates of how much finance you will need for two to three years or until you start to make a profit. Indicate contingency funds that might be needed for rough patches.

• Financial forecasts for a three- to five-year period. • How a loan will be repaid, how investors can get their money back, and when.

5. Choice of Investor / partnership

5. Who is interested to be an Equity holder in Refineries ?

• Crude Oil Producer – Secure market for the crude – Upgrade crude value – Available capital for projects [ moving down the supply chain –

economic and social development ]• Operators

– Profit– Secure baseload – Marketing access– Technical skills– Available and/ or access to capital

• Marketing of products – Secure supply of crude – Fair price – Market access – moving up the supply chain

5. Private Sector – Decision Tree

• A) Yes / No :- • Security ; safety of employees ;

• B) High Concerns • Security and sustainability ; ability to operate without

disruptions • License & Permits validity [ political stability ] and

enforcement [ legal ]• Expropriation • Corruption & lack of transparency

• C) Standard Concern • Likely return on investment • Future opportunities in country • Company’s comfort with the type of project, operating

environment and skill requirement

5. Host State Concerns in PetroleumDevelopment

• The following are the key issues that a host state wants to see addressed in its downstream petroleum regime:-

– fair sharing of the fiscal "pie”

– Security of supply of needed products

– minimize costs, and fair access to facilities (downstream issues)

– protection of the environment

– proper treatment of residents and communities affected by development

– training and education of citizens

– purchase of local goods & services

– reasonable controls over development activity

5. Mitigating Concerns/ Risks / Uncertainties

• Balancing Actions for Success

• Private sector concerns

• Host State concerns

• Alignment of resources

• Funding / investor “Model”

• Transparency

The Ingredients for success:- -Partners complement each other & work as harmonious team-Professional standing is compatible & minimum duplication in functional responsibilities-Strategic & functional alignment of the two companies-Maximum efficiency with shared vision & mission.

5

5. Six Keys to Public - Private Partnership

• 1. Statutory & Political Environment – Commitment from the top

• 2. Public Sector Organised Structure – Public Sector must remain involved

• 3. Detailed Business Plan ( Contract )– Clear , carefully developed plan describing responsibilities with clearly defined

method for dispute resolution • 4. Guaranteed Revenue Stream

– There must be the Means of repayment of investment • 5. Stakeholder Support

– Relevant interest groups • 6. Pick Your Partner Carefully

– The lowest bid is not always the best criteria for selecting a partner

6. Funding of Project

• 1. Availability of Capital and Funding

• 2. Preferred Options for Funding

• 3. Capital Market

• 4. Tailoring to Target Audience

• 5. Rating Factors

6.1 Availability of Capital & Funding

• Is Capital & Funding Available ? Yes .

• Who provides it ? bank ; private placement lending ; capital markets ; etc….

• In what form? Loans or debt,  that are structured and procured in a multitude of ways, dependant on requirements and circumstances.

• What type of structuring?1. Instrument :- loans  are secured by  various  irrevocable  and  unconditional guarantees . Rates on such  loans can be  extremely marginal  over LIBOR.  2. Contract:- financing is available for project developers and suppliers with an offtake  purchaser  in place.  Contracts can be  monetized to  provide  100% of the project costs to the developer / supplier.3. Asset- Asset -Backed Financing  (ABF)  refers  generically to all forms of financing  where a  financier has  a  claim  over  specific assets  being  financed.  ABF is unique  in that it  typically involves  fixed rate, long term loans without any financial covenants attached. 4. Cash Flow:- Cash Flow    loans  refers  to  financing  against  projected  or expected cash flows. either  of  the  existing  company  or  target  acquisition / new  project.  A  variety  of parameters and analytics are used for cash flow loans.

Appetite for lending diminishes with risk & uncertainty

6.1 Funding - Remarks -

• Funds shy away from risky projects & appetite for investing diminishes with risk and uncertainty.

• Infrastructure projects “target” meeting a blend of objectives :- strategic ; social ; economical with value addition & sustainability ; environmentally acceptable; synergistic with the overall development plan.

• The marketing of the project , for major funding, is carried out after the completion of the Business plan .

• Bankable Detailed Feasibility Study of the project will shorten the list of funding tools most suited to the project.

• All markets have Sellers & Buyers. The Project owner [ Enterprise ] is the Seller & the Buyer is the provider of funds to secure a share of the rewards from the project.

6.1 Funding Tools

• Government of Iraq.• International ( Sovereign supported ) Agencies [ e.g.

World Bank ]• private sector, including foreign investors and creditors:-

– Investment Trusts– Pension Funds – Private Equity– Hedge Funds– Insurance companies – Banks – Foreign Sovereign Funds– Private investors

6.2 Preferred Options for Funding

• Internal Funding:- “Rating of project” excludes Country risk.– Iraq's central bank [e.g. issue new treasury bills

to finance infrastructure projects]. – Any Pension Funds ; Religious Funds / Awkaf &

Institutional investors– Any private sector ?

• With or without Internal Funding , you may need :- – External Funding:- “Rating of project” includes

Country risk

6.3 Capital Market

• Developments on the buy & sell sides of the capital market are driving this market’s growth. On the sell side, projects are becoming larger. Consequently their capital needs have increased substantially .

• At the same time , the capacity of sovereign governments and sovereign supported agencies , including bilateral and multilateral lending agencies , to fund the debt portion of projects has diminished . Even strong sovereign , with substantial capital resources , will not be able to fund all their future capital needs internally & therefore looking externally. Both government owned and private owned projects are considering using project financing on smaller projects as a way to shed financing and construction risks ; and on a larger project as a way to reduce operating risk as well.

• On the buy side , traditional funding for project debit are being augmented by direct investment from institutional investors .

• The establishment of investor accepted criteria for measuring project credit strength is most critical step. Rating standards will be key , as they provide independent benchmarks against which projects can be assessed.

6.3 Project Funding

• Use your business plan to get funding:-• A business plan is essential for your

enterprise. It is the roadmap for future development. It is a key document when you are looking for business/ project funding.

• It must help investors and lenders understand your vision and goals, explain how you are going to spend the invested or borrowed money and set out how this will benefit both them and the business.

6.4 Tailoring to Target Audience• Tailor your business plan to the target audience• A business plan serves a number of purposes and you may have to modify

information depending on your target audience.

• Your bank [ or funding source ] will be interested in:– how you intend to repay a loan or overdraft– what you are going to do with the money– how the loan will help the business to grow– what other loan or debt commitments you have– Most lenders operate a credit-scoring system. Make sure you give up-to-date and relevant

information.

• Tell potential investors about:– what you are going to do with the money– when and how you are going to pay it back– the expected return– your other sources of funding– your management's track record– Include a detailed forecast of your profits and cashflow.

6.5 Guidelines for :- Project Developers ; Investors in projects

• Seven Individual Rating Factors . Overall Rating depends on the interrelation of the factors [ important for risks and credit strengths].

– Output Sales Contract [ Off-take Agreement ].– Products revenues – Raw material cost and supply risks – Structure – Technology & construction risks – Off-taker credit strength – Projected financial results

6.5 Individual Rating Factors - Example

– Structure :-• Structural analysis is important in risk assessment . Provision of

safety net in case of project difficulties• Revenue stream is dependent on performance • Structure defines the conditions placed on the cash flow to

ensure the debit service • Capitalisation :- Importance of Equity .

– level of Equity depend on the technology and other risks – Highly capital intensive projects , which involve technology or

operating risks , demand higher equity participation– Financial flexibility to correct unexpected technical difficulties

• Structure should not allow different usage of funds .• Reserves ; provision of liquidity to ensure temporary difficulties

are contained [ e.g. Reserve = 6 months’ debit service ]• Insurance for damage covering replacement ; business

interruption cover

6.5 Individual Rating Factors -example

– Projected financial results:-• Focus on the cash coverage of fixed charges • Assessment of Cash coverage:-

– level of certainty of the cash flow in covering the operation , maintenance expenses & fixed charges

– Fixed charges = principal & interest on debit + land charges – Projections versus quality / certainty of cash coverage– Analysis of risks for each major revenue and expense .

Consideration of risks in forecasts , sensitivity analysis to adverse changes in assumptions

– Worst case scenario in :- Cash margins ; Operating availability ;

– In case of funding with floating rate or foreign currency debit that is not fully hedged , the risks .

– Increased Uncertainty or risks for a long –term credit assessment . Option to re-finance after the operation

7. Concluding Remarks

• There is a need to organise skilled resources to develop project definition acceptable to the providers of Funds and/or investors

• “Provider of Funds” or investors will need the comfort that all the risks and uncertainties are quantified and plans for mitigating such events are in place

• Engaging External parties in the form of Funding or investor/partner should be identified during the course of the project definition. The value addition of the external resource should provide a fair win/ win situation to both parties

• There are variety of options for the Engagement of external resource; but the final selection is based on the “value addition” and the alignment of the business objectives

• Make sure you know what you are doing if “ I DO IT MY WAY”.

THANK YOU