By Felix Ayanruoh
Part One of this article reviewed the Petroleum Industry Bill (PIB) and the need for foreign investment and project financing.
The most crucial issue in structuring a project finance transaction is the complex interplay among a wide range of project participants. The project sponsors are responsible for developing the project, which involves obtaining the necessary government approvals and permits, negotiating project documents, securing the financing and providing the technical, organizational, and financial resources to meet challenges that might affect the project.
A project sponsor can be a single company in the business of project development or a consortium of interested parties, including developers, construction contractors, equipment suppliers and end-users of the projects products.
Since foreign investors are the main focus of the Nigerian Petroleum Industry, a greater return of investment is expected due to higher level of risk – including political risk. However, the level of equity returns has become a sensitive political issue since an increase in equity return will almost invariably translate to price increases in petroleum products.
The project company is the central contracting party for the project documents and as the borrower under the financing agreements. Usually, the project company is a single purpose corporation, partnership or trust organized by the project sponsors with no assets other than those comprising the project itself and the financial resources provided by equity and debt investors.
The off-taker is the purchaser of the petroleum products. Since the off-taker is the sole provider of the revenue stream on which the project financing depends, the competence and creditworthiness of the off-taker is crucial to the bankability of the project. The recent removal of petroleum subsidy, coupled with the fact of the large market for refined product, the issue of off-takers creditworthiness becomes moot.
Debt has been the source of about three-quarters of all the money typically required for project finance in energy projects. The majority of this debt has involved both commercial debt providers and credit-enhanced loans from mission lenders – e.g., Export Credit Agencies (“ECAs”) and Multilateral Development Banks (“MDBs”). ECAs and MDBs have made it easy for relatively high-risk countries like Nigeria to obtain financing at terms similar to those in developing countries with less risky project environments.
The role of the Nigerian government in energy projects is seminal to the success of these transactions, and also needs its full support. For example, the PIB provides for the establishment of a legal and regulatory framework – the upstream petroleum inspectorate and the downstream petroleum regulatory agencies to administer enforce policies, laws and regulations to all aspect of the petroleum operations.
Mitigation of risk
The most important factor in any successful project finance transaction lies in the identification, analysis, allocation and mitigation of project risks. A project risk relates to events that could affect the core objective of the project. Such events can occur during development, construction and operation stages. Project risks can be classified as commercial, political as well as force majeure events – natural disaster.
Commercial risk includes cost overruns, delays and shortfall in project revenue caused by uncertain sales and prices. While political risk, on the other hand, involve the possibility of expropriation of assets, civil unrest, and change in labor policy and foreign exchange inconvertibility, change of administration, environment laws, and tax policies. Undeniably, militant unrest and price distortion of petroleum products were until recently clearly identifiable project risks associated with petroleum development in Nigeria.
Project risks can be mitigated through a variety of measures including different forms of guarantees and the involvement of certain types of parties e.g. a key state entity. Formal guarantee can be provided by host government or by multilateral and bilateral agencies.
Derivatives agreements can also be used to reduce or mitigate risks associated with price fluctuation, such as increase or decrease in gas prices. The finance package should include protection against fluctuation in gas price through hedging facilities such as forward sales and futures and options contracts.
Given the Nigerian government’s intention to establish a clear regulatory and fiscal regime, deregulation of the downstream sector and the establishment of the amnesty program, which has effectively addressed the issues of militancy unrest, the author is of the opinion that project financing of petroleum industry in Nigeria are “bankable” transactions – and hence, potentially attractive for financing by lenders or other debt holders.