William Stevens, Global Head of the Upstream Oil & Gas, Director of Resources and Energy Group, HSBC Bank sheds light on the financing strategies and the projects calendar in 2009, in the shadow of the current credit crisis
What is HSBC’s projects calendar for 2009 and has it been affected by the economic crisis compared to last year?
I would say that for projects, which are highly capital intensive where there is a requirement for a substantial amount of debt over longer tenors, we have seen a marked drop in financing activity since 2008.
Refineries and petrochemical projects have also become harder to finance, as concerns on a potential supply glut are compounded by concerns on slowing global demand.
This does not mean that raising long-term financing for midstream and downstream projects is impossible in the current market, only that lenders are being highly selective, are tightening terms and conditions, and are prioritizing their core clients. Further, lenders are requiring a considerable premium to margins and substantial ancillary business to support the allocation of capital.
As far as HSBC is concerned, we have a number of active advisory mandates relating to downstream projects, which are likely to come to the market as liquidity returns, and refinery/petrochemical margins improve.
Reduced activity in midstream and downstream has been offset by a strong deal flow in the upstream sector.
In Egypt, how far did the crisis affect the financing of petroleum projects?
Since the credit crisis began to take effect, there has been no major proof of illiquidity with respect to the financing of projects in Egypt. However, sponsors and financial advisors alike are cognizant of the challenges of raising debt and are structuring and pricing their facilities accordingly.
Some sponsors are sitting out the crisis due to a combination of factors including: (i) the need for cost re-evaluation amidst movement in oil prices, (ii) weighing up the benefit of revisiting the front end engineering design to add more sophisticated processes to ensure higher net margins, and (iii) the cooling international demand for products.
As far as upstream oil and gas financings are concerned, there is likely to be greater activity as lenders are attracted by higher returns, the promise of greater ancillary business, the shorter tenor of these transactions and the fact that upstream independents tend to refinance often as they replace reserves.
Are you planning to expand your investments by financing oil and gas projects in Europe?
We are active in upstream oil and gas financings in Europe as well as in other parts of the world. My remit since I joined HSBC has been to collate the existing book and develop a comprehensive strategy for future Reserve Based Lending activity at the Bank. We have now supported clients in seven key transactions in the last two years, most notably for Premier, where we co-led the acquisition finance of Oilexco’s North Sea assets, Apache, where HSBC co-led its $350 m facility in Australia, for PICO, where HSBC provided a $100 million bilateral facility in support of its Egyptian assets, and Salamander Energy, where HSBC acted as MLA for the $200 million financing of its development assets in Indonesia and Thailand. Most recently, we joined a bridge facility for Cairn plc, supporting its subsidiaries assets in India, and acceded as MLA to an existing facility in favor of Melrose Resources, a well-respected oil and gas independent with an extensive presence in Egypt.
In what way does financing upstream differ from regular financings?
Reserve-based finance is where a loan is collateralized by the value of the reserves of a company or project and where repayment of the debt comes from the revenue derived from sale of the field or fields’ production. Such facilities permit oil and gas companies to raise debt against future production, allowing them to meet ongoing working capital requirements, fund acquisitions or provide for development costs associated with non-producing assets. Structures are typically bespoke to take into account the specific nature of the asset portfolio of the borrower in question.
How do you determine the appropriate debt amount for your clients?
Essentially, borrowing availability is limited to the lesser of the forecast discounted cash flows from the oil and gas assets over the loan life divided by a cover ratio (in this case, the Loan Life Cover Ratio) and the forecast discounted cash flows over the asset life divided by a cover ratio (in this case, the Field Life Cover Ratio). Further, borrowing availability is restricted by a reserve tail – typically Lenders give no value to any cash flow beyond the point at which less than 25 percent of the economic reserves are left in the fields.
The reason independents benefit from Reserve Based Lending Techniques is that the facility is highly flexible, acting as and incubator for smaller oil and gas companies. In essence, the amount the borrower can draw is re-determined every 12 months according to revised production forecasts, and every six months according to capital and operating cost assumptions, as well as economic assumptions, including prevailing oil and gas prices. The principle is that for as long as the borrower is able to replace reserves or if commodity prices rise, it can continue to borrow more within a pre-agreed facility limit.
How do you see the future of upstream oil and gas projects over the coming two years?
With more certainty over oil prices and falling development costs, there is a strong opportunity for independents of critical mass to raise financing against their reserves. Tenors are typically up to seven years for upstream financing, thus the level of liquidity for this type of transaction is likely to remain healthy. To tap this liquidity, Borrowers need to demonstrate a strong management and technical capability, fully funded capex plans and a strong track record of reserve replacement.
Are there any new projects or investments for HSBC to be announced soon?
We have a strong pipeline of transactions for 2009 and in an ideal world I would like to work on most of them. We must however remain client focused and strategy not transaction driven, no matter how strong certain opportunities may seem. One key transaction we are currently working on is a new facility for PICO in Egypt.
What are the major countries HSBC is focusing on to invest in upstream projects?
In line with the general strategy of HSBC, our target clients are likely to have a core focus on emerging market risk, particularly in areas in which the bank is committed to expanding its credentials, namely N. Africa, S.E Asia, W. Africa and the Middle East. Notwithstanding this, should the opportunity arise in OECD areas, particularly the North Sea, we are considering on a case-by-case basis.
What is HSBC Egypt play role in HSBC’s global oil and gas investments?
The Cairo office plays an essential role in the development of our oil and gas business in Egypt. We are lucky to benefit from strong domestic Project Finance arranging and advisory expertise with support from our offices in London and the Middle East. What HSBC Egypt also provides is strong on-the-ground client contact, an understanding of the key independents operating in the country and the nature of the fiscal regime underpinning the assets.
Many industry players predict a big hike in oil prices. Do you agree with this analysis?
The market is characterized by over-reaction at present. Any spike will be short-lived and I agree with the in-house HSBC view that oil prices will settle at $75 per barrel by the end of 2009.
Are you considering renewable energy as a key part of your business going forward?
HSBC has an exceptionally strong renewables advisory and lending business. A dedicated team in London handles all our renewables activities, with a particular focus on the wind and solar sectors. With respect to oil and gas transactions, it is important to note that for all of our investments we conduct thorough due diligence and ensure that they conform to the Equator Principles regarding social and environmental standards.