Project finance is a long term financing tool with debt repayment being wholly reliant on the success of the project and creditworthiness as such, is a function of a bank’s ability to assess and predict this success. Let us be clear, project finance is not high risk but managed risk. Lenders and advisers undertake a rigorous due diligence process on each project with the benefit of independent advice on technical, environmental, market, legal and insurance aspects of a project.
Lenders will be looking to assess and manage all of the key project risks which will include:
– Will the project be built on time, to budget and to the required specification?
– Is there a sufficient supply of competitively priced feedstock?
– What is the market for the product and will the project be a low cost producer and therefore able to compete with other suppliers?
– What is the Sponsors motivation for their involvement in the project, is it consistent with their corporate strategy, are they able to meet their financial obligations to the project, do they have the required skills to both develop the project and manage operation?
Project finance is a highly sustainable form of finance, and in fact in some cases the only possible source of finance.
How many hydrocarbon projects have you provided finance to in Egypt?
HSBC Bank Egypt played a major role in financing landmark oil and gas projects in Egypt crucial to its national economy.
We financed many export oriented projects such as Egyptian LNG Train 1 and 2, Egypt Basic Industries Corporation and Egyptian Fertilizers Co. The bank also financed the Fayum natural gas distribution network for industrial, commercial and domestic users. All projects were very successful and construction fully completed. It is also worth mentioning that HSBC acted as Financial Adviser to the Egyptian Methanex Methanol Company, a project company established to build a 1.3 million tonne per annum methanol facility in Damietta Port.
HSBC is currently advising Egypt Hydrocarbon Corporation on its development of a Greenfield Olefins Complex consisting of a 2.5 MTPA Naphtha Cracker and 2 x 450,000 MTPA Polyethylene Complex at Ain Sokhna on the Suez coast of Egypt. In brief, we are following both the upstream and downstream sectors developments in Egypt very closely. We work right across the industry’s value chain from upstream through refining and transmission/distribution to liquefied natural gas and petrochemicals. We also cover extensively the related service sector.
We also lead arranged a US$ 500 million jack-up rig financing deal with Egyptian Oil Drilling Company (EODC). The project, sponsored by Egyptian National Oil Companies and Toyota Corporation, saw EODC purchasing two offshore drilling rigs from PPL in Singapore. We had a lead arranging role with Japan Bank for International Corporation (JBIC), a first for them in 20 years.
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% 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 an ‘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 6 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. Conversely, if reserves fall and/or or the oil price falls, the Borrower is obligated to prepay to achieve the cover ratios described above.
How do you see the future of upstream oil and gas projects in the coming 2 years?
With more certainty over oil prices and with falling development costs, there is a strong opportunity for independents of critical mass to raise financing against their reserves. Tenors are typically up to 7 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: (i) a strong management and technical capability, (ii) fully funded capex plans, and (iii) a strong track record of reserve replacement.
What are HSBC’s near future precautions related to investing in oil and gas projects?
We look to support clients with a lower quantum of production risk (i.e. their assets are producing, or have a mixture of producing assets or development assets which have achieved consent. Further, clients would need to demonstrate: (i) strong management and engineering capabilities, (ii) low operations risk, (ii) fully funded capital expenditure plans, (iiii) a good sales structure, with an ability to get product to market and (v) cash flow where price risk is mitigated by hedging or where the breakeven oil price is sufficiently low and the assumptions used to size the facility are sufficiently conservative. Further, given the current liquidity crisis, we would only look to support companies which do not rely on an increasing pool of liquidity to fund their capex plans and have sufficient equity and debt commitments in place to cover their requirements.