Legislature(2007 - 2008)HOUSE FINANCE 519
04/25/2007 01:30 PM House FINANCE
| Audio | Topic |
|---|---|
| Start | |
| HB228 | |
| HB184 | |
| SB103 | |
| HB88 | |
| Adjourn |
* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
+ teleconferenced
= bill was previously heard/scheduled
| + | HB 184 | TELECONFERENCED | |
| + | HB 228 | TELECONFERENCED | |
| + | SB 103 | TELECONFERENCED | |
| + | TELECONFERENCED | ||
| += | HB 88 | TELECONFERENCED | |
HOUSE BILL NO. 88
An Act relating to televisions, monitors, portable
computers, and similar devices in motor vehicles; and
providing for an effective date.
REPRESENTATIVE CARL GATTO, SPONSOR, noted that the bill
stipulates "No watching television (TV) while driving". It
has been corrected from concerns previous voiced. It will
protect people; when a car is in motion, the driver can not
be watching TV. Important language was added to Page 1,
Line 11, "in full view".
3:32:27 PM
Co-Chair Chenault asked if it would affect the Global
Positioning System (GPS) display. Representative Gatto
responded that the exemptions are listed in Section C, Page
2.
3:33:34 PM
Vice Chair Stoltze MOVED to ADOPT work draft #25-LS0312\O,
Luckhaupt, 3/12/07, as the version of the bill before the
Committee. There being NO OBJECTION, it was adopted.
3:34:25 PM
Representative Hawker recommended language "personal data
devices" rather than "personal data assistance".
Representative Gatto thought that would be a good change.
PUBLIC TESTIMONY CLOSED
Co-Chair Meyer recommended that the bill be held in Committee
for final review.
Representative Hawker referenced Section 2, asking why the
definition of physical injury terms had been incorporated.
NORM COHEN, STAFF, REPRESENTATIVE MAX GRUENBERG, pointed out
that on Page 3, Lines 5-7, there is clarifying language from
Title 11 to Title 28, moving the physical injury definition.
Representative Hawker inquired if the Department of Law
agreed with that definition of physical injury.
ANNE CARPENETI, ASSISTANT ATTORNEY GENERAL, LEGAL SERVICES
SECTION-JUNEAU, CRIMINAL DIVISION, DEPARTMENT OF LAW, stated
that the Department does concur with that definition.
3:38:22 PM
HB 88 was HELD in Committee for further consideration.
RECESS: 3:41:28 PM
RECONVENE: 4:11:29 PM
^
OVERVIEW:
PRESENTATION BY SULLIVAN & CROMWELL LLP
FREDERIC C RICH, PROJECT FINANCE GROUP, SULLIVAN & CROMWELL,
provided members with a slide presentation: Project Finance
Workshop, An Introduction to Project Finance for Oil, Gas and
Pipelines (copy on file.) Sullivan and Cromwell is an
international law firm based in New York. Their project
finance practice focuses on large projects, averaging over a
billion dollars. He noted that the presentation was based on
a workshop with the Department Of Energy, Treasury, and
Office of Management and Budget and was intended to give them
the ability to understand in what context federal loan
guarantees would might be used and what issues might arise.
The presentation was designed to provide information on
project finance, as opposed to corporate finance and provide
tools for risk allocation and mitigation. He noted that the
presentation would cover current project finance markets,
building blocks of a typical project and projects specific to
oil, gas and pipelines.
Mr. Rich observed that there is little precedent for projects
like the Alaskan Natural Gas Pipeline (page 2). He added that
92 percent of closed projects are under a billion dollars.
The largest previous pipeline financing was the Alliance Gas
project at $2.6 billion. He noted that the largest project
ever entered was $6.7 billion [Taiwan High Speed Rail
Project]. The Alaska Gas pipeline would set a new record.
Mr. Rich observed that there are many unknowns. He stressed
that what worked for and applied to other deals may not work
in Alaska. He noted that it is premature to discuss
specifics, but observed that he could speak to the main
drivers of oil, gas and pipeline financing in general. He
stressed that bank-ability does not exist. Lenders will
accept more if the economics are strong. When there is so
much "hair on the dog" lenders will bulk, but the line is
hard to draw. The process tries to determine "hair on the
dog".
4:21:35 PM
Mr. Rich spoke to slide 3. Project finance is distinguished
by a project entity that provides a product or service to
buyers. A portion of the sales proceeds are used to repay
debt. Before the project is operational the equity portion of
the capital costs comes from the sponsors. "Sponsors" in
Alaska are generally identified with the producer group, but
"sponsor" is a term of art in project finance, which means
whoever owns the project entity. Project financing has
previously been applied to power plants. Today project
financing is not a single financing product, but different
products for different markets. He cautioned members to
beware of generalizations.
4:24:23 PM
Mr. Rich noted that project finance is different from
corporate finance. Project finance is tailored to the risk
profile of the individual project, it is highly structured
and engineered, non-diversified credit, and is green field
(once the loan is dispersed there is no way to repay the
loan; there is no credit.) Project finance is cash-flow based
credit (unlike real estate). Payments only occur if cash flow
is generated such as gas going through a pipeline. Project
Finance is generally based on contractual commitments because
project lenders are not willing to take the risk that the
cash flow will be generated. Contracts must be shown. There
is limited recourse; the single purpose entity does not share
the loan.
Project finance is tailored. Lenders design the financing to
reflect the economic profile of the project. Financing is
tailored to the project cash flow and risk profile for the
specific project. Lenders are focused on repayment. The whole
project finance field is based on what could go wrong.
4:29:37 PM
Mr. Rich spoke to the structure. The product credit is based
on completion support, who took the risk that the project
would be finished, who took the risk for overruns and delays,
how was the cash flow captured, what were the off take
commitments, what did the contracts say (under what
circumstances do those taking the product have to pay),
security interests, remedies if the loan is not repaid or is
in trouble; and project covenants and structured remedies.
The structure is made as needed to reflect the risks inherent
in the project.
Mr. Rich noted that project finance starts with reserves;
someone is the shipper; someone pays a tariff (the tariff
that they paid to the pipeline company is the only source of
debt service). These things are non-diversified, but every
project must be reviewed for what is in and what is out of
the project: How is credit defined? What recourse exits?
Repayment is dependent on how those outside the project
fulfill their commitments. Structural issues are created when
things out side the project are needed for repayment.
4:33:18 PM
Mr. Rich explained "Greenfield" (page 12), which means when
the loan is disbursed, the business does not exist. It is
relatively rare. The question is would the project get built
on time, with in budget and will it work as promised,
minimizing likelihood of force. Lenders do not take this
risk. At completion the loans would be non-recourse. Before
that time the project can not provide repayment because it
hasn't demonstrated its ability to repay. Completion support
is virtually always required in project finance. Completion
guarantees occur from the sponsor or shareholders of the
project entity; they guarantee the debt until completion. If
completion does not occur by the "drop dead" date repayment
would be required. The guarantees are released once
completion has been certified. He maintained that this is the
main reason why good projects don't occur and provided
examples.
4:37:30 PM
Mr. Rich spoke to federal guarantees for completion support.
He explained that the guarantees are guarantees of
completion. Section 1(16) of federal statute requires
completion support and guarantees. The debt is guaranteed
until the completion test is met. There is precedent in the
pipeline world for completion support that falls short of the
guarantee. In the case of Alliance, the owners of the project
company had to tell the lenders that they would commit to
putting in additional equity into the project up to an agreed
level if necessary to fund overruns (30 percent of the base
case capital costs).
4:39:45 PM
Mr. Rich spoke to pre-completion and post completion, which
are treated differently. During pre-completion shareholders
or sponsors are putting in equity and the lenders are putting
in loans and paying construction costs. During post-
completion sales proceeds go in and operation costs and taxes
are paid first; then debt service. Owners receive a
distribution if there is anything left over. Lenders
proscribe the order that cash can be used.
The main metric used in project finance is called "cash-flow
available for debt service". The contract produces cash flow
revenues, which are projected. Taxes are fixed. Operating
costs are projected. The balance is the cash-flow available
for debt service. Lenders require that the cash-flow be
positive for every 6 months. The measure of the strength of
the credit is how positive the cash flow. If the ratio is 1/0
there would only be enough cash-flow to pay the debt. A ratio
of 3/0 means there is three times more cash then needed to
pay the debt. This is the cushion against the unexpected, and
against higher than anticipated operating costs. Curtailments
and interruptions are operating risks for pipelines. There
would be zero cash-flow during interruptions; therefore,
lenders protect themselves by requiring funded cash reserves.
4:44:21 PM
Mr. Rich discussed page 14, contractual commitments. There
will be some projects without contractual commitments,
especially in the oil industry or in merchant risk. However,
project finance is based on contractual commitments. The
credit worth of the parties making the commitment, terms of
the commitment, and the underlying fundamentals of a long
term project are considered. Contractual commitments are, in
general, an amount sufficient to cover debt service and an
agreed cushion, for a term no shorter than the term of debt.
Terms of the commitment are reviewed, as are underlying
fundamentals.
4:46:23 PM
Mr. Rich noted that "limited recourse" means that after
completion "you" can look only to the project. He Rich
observed that there is only one reason for project finance:
for funding. Project finance often occurs in the oil business
as a tool to mitigate risk or for opportunistic reasons. If
something goes wrong it hits the equity. If partners are
brought in, they share the risk, which limits the owner's
loss.
4:48:56 PM
In response to a question by Representative Samuels, Mr. Rich
explained that the shareholders are on the hook during pre-
completion through their completion guarantees. After
completion the lenders can only look to the asset of the
project, which includes a contract. Lenders can force owners
to enforce contracts. The off take contract is not a
guarantee, but a commercial agreement that provides that a
certain price at certain times under certain circumstances,
with certain exceptions. The person making an off take
contract takes the risk of their own business. A utility
takes the risk that their customers will need the electricity
in the case of a utility that enters into a long-term
contract to buy electricity from a power plant. They still
have to pay if their demand forecast is wrong. If a power
plant goes bad: doesn't get their environmental permits, or
is built wrong or is not working right, the risk is born by
the lenders. The contract is only one part of the entire
package that the lender considers.
4:52:07 PM
Mr. Rich spoke to 19, risk allocation and mitigation. Risk
allocation and mitigation starts by keeping in mind the
difference between debt and equity. "Sponsors" refers to the
shareholders. Leverage is of great importance to lenders; the
more equity the better. The concept is to have "skin in the
game". Lenders look at the percentage and quantum of the
equity. Equity is the first layer of loss in a project.
Equity suffers losses before the debt. In the case of a
billion dollar of debt on an $800 million dollar project, the
debt receives all the value.
Mr. Rich observed that lawyers make sure that projects are
non-recourse post completion, but that bankers have every
expectation that the owners will come in and fix the problem
due to their "skin in the game". He referred to a project in
the Caspian Sea. Underwriters used Chevron's logos on the
bond issuance prospectus to emphasize that, even though
Chevron did not owe the money, it was a Chevron project and
they had a billion dollar of "skin in the game". Lenders look
at shareholders through their equity stake as for risk, the
lower the gearing, the lower the leverage. A project with
50%/50% equity/debt is more attractive than a project with
20%/80% equity/debt.
4:56:14 PM
Mr. Rich spoke to risk allocation. There is no risk
allocation from the equity. Every risk is born by the equity,
but within the debt portion, risks are allocated. Project
financing is more about risk allocation than fund raising,
since it allows "you" to make a list everything that could go
wrong and allocate who bears the risk. In a gas market the
lenders require others through committed contracts to bear
the risk. Tax and regulatory risk is often shifted to or
assumed by the host government through stability insurances.
Mr. Rich reviewed risk allocation and mitigation (slide 22).
The focus is on completion risk because lenders look at risk
in two stages. Mitigation answers the question: Has
everything been done to mitigate the risk? Completion risk
(the risk that it is going to get done on time and on budget)
looks at: quality and feasibility that the work will be on
budget; contracting strategy (if available); quality of
project execution; and budgeted contingency. He observed that
with the Alliance project, 87 percent of the costs were under
fixed cost contract for procurement: pipe, heavy equipment.
With fixed cost contracts the supplier is taking a risk that
prices will increase. The Alliance project still required 30
percent in overrun commitments from shareholders even though
87 percent of the costs were fixed. Contracting strategy is
not usually an option on big projects. Quality of project
execution, the track record of the project shareholders, the
size of the budgeted contingency and pre-committed overrun
financing are mitigates. Lenders will not take the risk if
there are cost overruns in excess of the amount of available
funds; the allocation is through sponsor completion support
or guarantees. Risk is allocated away from lenders to
shareholders.
5:00:55 PM
Mr. Rich discussed the risk matrix. The risk matrix, in which
risk is identified and mitigation considered is the first
step and determines risk allocation.
5:02:47 PM
Mr. Rich explained that any project starts with the reserves,
which are either there or not. Decisions can be made in the
area of: project structure, commercial and governmental
arrangements, and contractual commitments. All these
decisions affect the mitigation and define the project
credit. There is a natural (givens) a synthetic credit (due
to the decisions made). Financing terms and conditions can
only be tailored once the credit is identified.
5:04:40 PM
Mr. Rich noted that the guarantor (federal or other), to the
extent of the guarantee, is the lender and has the same debt
as the owner. The lender (and worrier) is the government if
the debt in a project is fully guaranteed [by the federal
government]. He gave examples of federal guarantee criteria:
reasonable insurance of repayment of the guaranteed debt, and
the terms and conditions must provide adequate terms and
security to appropriately protect the financial interests of
the United States. The federal government hires bankers and
commercial advisors to tell it what is required. The
existence of a federal guarantee does not change anything. If
the entity defaults, the federal government would pay the
lender and then own the asset and would have all the same
rights as the lender, to create a change in lender
transactions. All the conditions remain. The federal
government has responsibilities to be fiscally responsible as
an arms length transaction. From the borrowers perspective
there would be no change.
5:09:05 PM
Mr. Rich discussed the global finance market on page 27. Oil
and gas is growing in the market. Oil and gas pipelines are
still a small portion. Distribution changes from year to
year. The size of the market changes dramatically as there is
high volatility and is driven by demand. He referred to the
graph on page 28. Small projects can be completed in 6
months, which provides greater odds that the market will
remain in the same proportion. Mega projects have no idea
what the market will look like by the time the project comes
to completion. Today's markets are good for project
financing, but it is impossible to predict the future. Large
projects are based on market neutral decisions. Only 15.7
percent is domestic US value. The global market is largely
outside of the US. The [AGIA] project is not going to lead
the market incrementally into new territory; it will be a
quantum leap. AGIA would be a multiple of the largest
financing done to date. It would be an incremental leap that
is unprecedented. What is necessary to make it bankable? Some
things may be easier because it is a high profile strategic
project; some things will be hard because of the size.
5:14:15 PM
Mr. Rich reviewed slide 30. Project finance is market
dependent. The bond market is considered more desirable for
large projects. Capital markets are deep. Large liquid bonds
are attractive. The bank market is generally a 10 to 12 year
market. Large projects beyond 15 years are almost forced to
be done in the bond market. The capacity of the bank market
has increased, but depending on the length of maturity it may
be the only option. The bond market is even more volatile.
They may be times when the bond market is not available. The
general approach is for multi track finance plan to make it
work for both the bank and bond markets. The federal
guarantee would make the bond market almost irresistible.
5:16:59 PM
Mr. Rich explained that the statutes state that the
Department of Energy (DOE) may guarantee up to 80 percent of
the total project costs. The intent of the statute is to
provide an incentive. He maintained that the DOE should cover
100 percent of the debt portion subject to the limit that it
can't be more than 80 percent of the project cost. Standard
practice in the federal government is for 80 percent of the
debt. The federal government wants the lender to have "skin
in the game"; it's an insurance deductible. The federal
government would have the entire burden for making decisions
regarding financing, what's adequate and required, what is
good enough and what the risk is, and the administration of
the loan if the federal government guarantees 100 percent.
This is enormous. The uncovered portion of 80 percent of 80
percent could be the largest oil and gas financing ever done.
Other projects have tried to engineer a federal guarantee for
the uncovered portion through bonds and trusts, but this has
now been outlawed. He concluded that there are a lot of
different forks in the road, but the 80 percent federal
guarantee is one of the largest.
5:20:02 PM
Mr. Rich discussed slide 31. The S&P credit was found to be,
in general, better than anyone thought. Any owner of the
pipeline would want the guarantees to be appropriated, in
which the U.S government pays the price of the credit risk
through appropriation or the borrower has to pay. Any owner
would want the guarantees appropriated or the price paid to
be the lowest possible.
5:21:29 PM
Representative Samuels referred to the 80 percent of 80
percent and questioned if the federal determination has been
made. Mr. Rich noted that it is yet to be determined if it is
80 percent of 80 percent of the total costs. The statute does
not answer the question; the statute simply gives a maximum
and is silent on what percentage of the debt can be
guaranteed. He felt that allow 100 percent would be in
keeping with legislative intent, but cautioned that universal
practice is 80 percent of the debt.
5:23:14 PM
Senator Therriault questioned if anything could be read into
the lack of clarity in statute. Mr. Rich could not comment on
the politics, but felt it was a big problem and creates
uncertainty. The ability to fully understand the issues
awaits clarification.
Representative Doogan referred to slide 28 and asked how an
Alaska gas pipeline would compete. Mr. Rich pointed out that
only a small portion of oil and gas projects only $15.7 of
the $180 billion was U.S. domestic. The ANGA is larger than
the entire relevant market. The issue is complicated. A 100
percent federal guarantee has different risk, since it is
liquid and deep and large. It would be a challenge under any
scenario without the federal 100 percent guarantee. Market
conditions are important. People tend to tackle each point as
they can. Low prices equate to low tariffs, which is good for
everyone. There is complete alignment on the things that
reduce pricing. "In a normal mega project what everyone does
is just gets as many of them as they can and tries to make
sure they have the best possible product, the best mitigates
to those risks, when they approach the financing markets."
Representative Doogan summarized that if the money is there
it's not a good deal. Mr. Rich added that there could still
be a scenario with market challenges even if it's a good
deal. Unlike other project financings that happen all at
once, the construction period for the pipeline is
considerable. The demand for capital would be sequenced over
a period. The entire $18 billion would occur over a series of
years.
5:28:58 PM
Mr. Rich explained the three phases of a typical project
financing: structuring of the project, finance plan (when the
project and risk is known and the best financing is
determined), financing project (the actual execution). He
noted the process is complicated and gave examples of pass
through structures. Pass-through structures tend to be highly
tax efficient, from a federal prospective. Multi shareholder
projects are common with: utilities, gas merchants, producers
and pipeline development companies. Each has different
objectives, tax consequences and different ways of looking at
the world. In the oil and gas business severalty tends to be
key, so that they are not locked into a single entity or a
single set of decisions. A lot of time is spent figuring out
what the project is. There is generally some kind of
government agreement at the base such as: concessions and
resource project for infrastructure like toll roads;
investment agreements, and investment incentives. Federal
legislation successfully mitigates licensing and permitting
risks. The project has structure, agreements and commercial
contracts. The model can't be designed until these items are
known. Agreements between the participants can be quite
complicated.
5:32:56 PM
Mr. Rich spoke to leverage and how the debt is raised and how
much. Questions about leverage and gearing are part of the
FERC methodology, which are assumptions made for calculating
the returns and the rate base. The assumption does not equal
the real world. The optimum model for project financing is a
complicated question; it is not always the highest degree of
leverage. The cash flow model determines how much debt can be
borrowed and over what period it can be borrowed. Leverage
and debt are computed based on the ability of the
shareholders to bear the completion risk, based on the down
side scenarios and other factors. The leverage or gearing in
a project can not be assumed to be the leverage or gearing
permitted for regulatory purposes.
5:35:00 PM
Mr. Rich spoke financing plans. Strategic projects have
special challenges. He questioned if it would ever be the
right thing to allow lenders to take the project off the
market. There are a whole set of reasons in strategic
projects why a typical finance plan might not work, which is
not good for lenders, because it is not the typical package.
The challenge is to design a finance plan that produces "our
relatively un-hairy dog," meets state and federal statute
restraints, and is acceptable to all concerned including the
federal guarantor if there is one.
5:36:42 PM
Mr. Rich discussed the "waterfall": slide 41. All the
projects assets are required to be set aside in a separate
account, in which the lenders have an interest. The lenders
or trustees that act for them set the rules for how the cash
flow will be applied. Distributions to owners occur after
these operating costs, taxes, and large debt service reserves
have been met.
The upstream and midstream might be financed separately.
Pipeline lenders will not get a penny unless upstream is
brought into production; the upstream lenders will not get a
penny unless the pipeline is built and the gas can be
transported to market. Waterfalls are considered on an
integrated basis. The upstream lenders are always
subordinated to the mid-stream lenders. The super-priority
for the upstream lender is to pay the tariff. Everything is
embedded in the tariff; all of the midstream waterfall is
embedded in the tariff and is a priority in the upstream.
Transportation costs have to be paid first. The tariff
constitutes a pass through. Midstream lenders think
holistically because they are not paid until the upstream is
a success. The likelihood of payment is dependent on the
success of the project.
5:40:26 PM
Mr. Rich explained that additional debt is one of the hardest
fought covenants in any project financing, since the only
thing left after the completion guarantee is the project.
Additional debt adds a burden that was not anticipated.
Lender consent is the norm. Capital markets get sometimes get
objective tests based on pro forma of debt cover and leverage
tests. He gave examples based on borrowing for expansion. The
maturity of the debt cannot be shorter. The weighted average
life cannot be faster, and an independent debt model must be
run. The model must demonstrate that the expansion and
expansion debt will not inhibit the payment of existing debt.
Project shareholders want maximum flexibility, but lenders
want protection.
5:42:54 PM
Mr. Rich observed that another hard fought component of the
finance plan is the completion test, which has physical,
operational, and financial elements (slide 43). An
independent engineer checks the project from the startup
period. The financial test must demonstrate that the off
takers are still credit worthy. Assumptions on the off take
contracts are based on credit. Credit ratings are examined on
those involved before the guarantee is removed.
The form of the shareholder completion support is highly
negotiated. Ten years ago there was little worry about large
projects, but unexpected blowouts have occurred. The current
market focuses strongly on completion support. He didn't
think a deal such as Alliance's with 30 percent overrun
commitments could be negotiated in the current climate.
The federal statute requires the DOE to have completion
support and guarantees. He expected financial and commercial
advisers to the DOE aspect to be among the toughest in
negotiations. It is in the interest of the shareholder not to
have guarantees, since normal completion guarantees are
guarantees of indebtedness and go on to the financial
statements. They would result in a huge debt load through
completion, since they only fall away when the completion
test is met. The agreement is to pay back the entirety of the
debt if completion is not reached. On the other hand, equity
overrun commitment support is limited risk, since it is a
capped amount. He anticipated that pipeline developers would
prefer to make equity overrun commitments.
Representative Kelly asked how the federal guarantee ties
into the debt. Mr. Rich explained that the language in the
statute referred to "completion support and guarantees". He
interpreted the statute to mean one or the other: either the
debt is guaranteed until the completion test is met or the
debt is not guaranteed, but an additional amount of equity is
guaranteed in the case of overruns. He stated that it would
be rare to do both. He suggested that DOE regulations could
clarify market practice. He noted that 30 percent of the base
case capital cost is more than the entire capitalization of
most of the players in the market. The need for the financial
engineering around meeting the completion requirement is
formidable. The guarantee doesn't change anything and the
ability to deal with the completion support requirement is
what allows projects to succeed or causes them to fail. Good
projects fail due to an inability to meet the completion
support requirement.
Representative Coghill concluded that the supports that fall
away after the completion can carry their own costs; supports
fall on companies that needed to put up the equity prior to
completion.
5:51:56 PM
In response to a question by Representative Kelly, Mr. Rich
explained that, if there are completion guarantees, pre-
completion the margin on the loan reflects the person giving
the guarantee. A higher margin is paid in post completion.
The federal government could give 100 percent guarantee
either after completion or on day one. The federal government
would require the completion guarantee from the shareholders
of the pipeline company if their guarantee occurred on day
one. Under the first alternative (the guarantee occurs on
completion) the borrower pays the cost of the credit. Under
the second alternative (the guarantee occurs from the first
day) the borrower only pays the lowest cost because it is
covered by the guarantee. The cost difference results from
the federal charge for its risk. The federal government
places a value on the guarantee depending on the strength of
the completion guarantee. The U.S. tax payer bears the cost
if the guarantee is appropriated. The project company should
pay a higher price pre-completion if the guarantee is not
appropriated.
5:55:16 PM
Mr. Rich explained that the Department of Energy (DOE) put
out a NOI (notice of inquiry) asking if regulations should be
promulgated; the DOE decided not to do so at this point. He
recommended that financing regulations remain flexible to
allow whoever the owners are to go to the DOE and try to get
a guarantee that they can actually use.
Mr. Rich observed that it is not easy to put together a mega
project financing plan. Success depends on good management
and leadership; the financial costs are high. He advised an
early start. The cost of delay in a mega project is huge.
5:59:54 PM
Mr. Rich referenced Page 48: Why lenders like oil, gas &
pipeline projects. He observed that past experiences have
been good; lenders like resource based lending for upstream
projects and contractual based lending for pipelines;
technologies are usually well proven; there is clarity in the
cash flow; and the upstream has commodity products. Price
risk is the main concern, however, lenders believe that risk
can be understood and priced with the use of engineers and
other advisors. Lenders also like the sponsors: big oil.
Strategic projects are preferred.
Mr. Rich reviewed Page 49 - upstream versus the midstream
pipelines. Upstream projects are simple. Gas projects depend
on available transportation and markets. The fundamentals are
the same for upstream and mid stream. Lenders want to know
about reserves and markets. Gas is harder to finance than
oil.
6:03:01 PM
Mr. Rich addressed the midstream credits - Page 50.
Midstream is often developed in an integrated fashion with
the upstream (outside of North America). A lot of midstream
is developed separately, but with producers as owners (either
in whole or part). It is important to look at the nature of
the links on the upstream. Downstream adds a layer of credit
risk. He spoke to the nature of transportation commitments.
Projects where the downstream buyers are the shippers look
different to lenders than commitments from the upstream
producers. The downstream adds another layer of credit risk.
The nature of the transportation commitments and tariff
structure must also be considered.
6:06:39 PM
Mr. Rich referenced Page 51 - main pipeline financing
approaches. Pressure for integration [of midstream and
upstream] comes from both sides. Producers worry about timely
development of transportation, control of construction and
operating costs, and reliability. Many of the overseas
projects are done on an intergraded basis, where the up and
mid streams are developed as part of a single project or the
upstream producers play a large role in the ownership and
development of the midstream. Lenders have a similar set of
concerns because they are dependent on the upstream and
reserves. The contracts are the only link between the
midstream lenders and upstream producers. All the risks that
lenders want mitigated have to be in the contracts.
Mr. Rich spoke to Dual Project Risk - Page 52. In this case,
the lenders to the midstream are exposed to the upstream risk
without being in their projects. Representation of the
upstream reserves is important for lenders. The completion
test will determine if the upstream has been successfully
developed and produced because "if it isn't they don't get
paid". Unless there is a guarantee there is no "hook" into a
corporate credit. The contract is the beginning of the story.
Lenders look at the credit behind the contract and the
circumstances under which the contract would or would not be
performed. Credit risk is the amount paid when owed.
Representative Samuels asked if the lender would look at the
depth of the worldwide pockets where a pipeline entity had a
shipping contract. Mr. Rich replied that the lenders would
ascertain the identity of the company, their assets and
credit, guarantees and the rate to which they allow their
affiliates to fail. The second question is how likely, as a
commercial matter, that it would be economical for the
contract to be performed. These calculations on the upstream
are the heart of the midstream credit determination. He
concluded that the Alaska project would need to be economical
for the next 30 years.
Representative Kelly asked if the project was a double green
field project. Mr. Rich replied that it has the qualities of
a green field project. Representative Kelly asked if he knew
of any projects that were economical based solely on the
midstream component. Mr. Rich replied that he did not.
6:17:28 PM
Mr. Rich highlighted Page 53, transportation agreements. The
length of transportation commitments should be longer than
the length of the debt. Volume, shipper credit, force majeure
and federal guarantees are reviewed. Blended credit is the
starting point for the credit analysis. The percentage of the
total capacity and credit rating behind each commitment is
reviewed and are calculated on an average weighted blend.
"The strength of the credit they are looking for will be a
function of how they perceive the risk of the project and in
particular the tenor of the loan". Overall, they will look
for the cost structure. The pressure will be greater if they
are looking at 30 years rather than 10 - 15 years. He
observed that the general FERC scheme is to pass through
costs in the rate base. The netback and the economic
viability of the whole scheme are considered. In terms of
cash flow available for debt coverage, they will focus on
whether the cost lands in the mid or up stream; overall they
are looking for cost reduction in a total cost picture that
demonstrates that the whole enterprise is sustainable. There
are occasions when shippers prefer not to enter into shipper
pay commitments. They are not required overseas and there are
instances where pipeline developers cannot get producers to
take these types of risk.
6:21:11 PM
Mr. Rich reviewed force majeure. Force majeure is one of the
circumstances in which the firm transportation contract, buy
it's terms, doesn't provide cash flow to pay the debt. These
contracts are intended to not forgive the shippers (in this
case the producer) for problems with the upstream reservoir
if the reserves or market are not present. They do forgive
the shipper if the pipeline has been interrupted or
curtailed. Lenders to the midstream are taking pipeline,
technical performance risk over a long period of time.
Assumptions have to be made about the people who have
engineered and developed or will operate the project.
Implementation varies by contract. Shippers are not obligated
to pay if the midstream cannot accept the gas.
6:22:54 PM
Representative Doogan provided a hypothetical situation
regarding firm transportation contracts: one with an
independent pipeline company and the other with a limited
liability corporation connected to the parent company. He
questioned which would be more bankable. Nr. Rich explained
that the later would be more bankable. The projects would
still be separate in regards to regulation. The owners of the
upstream would be shareholders in the pipeline, which would
add confidence to the project. The big upstream companies
would be in a position to make sure the mid stream was
developed in a timely way with the least cost. Risk
allocation, allocates the risk to the parties that are in the
position to control the risk. Capital cost of the project is
one of the biggest risks born by the shippers, since it goes
right into the tariff. Shippers are not in a position to
control the midstream if they are not shareholders. They
would prefer shareholding as a lending manner.
6:26:10 PM
Representative Doogan understood that integration would come
if production and pipeline construction were the same company
or if there were some other legal connection, but questioned
where the market would get its confidence in the case where a
limited liability company or other free standing company were
created in order to build a pipeline. Mr. Rich explained
that project finance is based on expectations and
calculations of what will motivate people in the future and
the percentage of ownership. In some instances, lenders have
required upstream owners to retain at least 51 percent in the
midstream. They were counting that the upstream would have a
controlling position. The mentality is: Are those bearing the
economic risk in the position to exercise control?
6:28:35 PM
Representative Samuels noted that in some foreign companies,
shippers are not required to pledge firm transportation
commitments and questioned if governments finance these
projects. Mr. Rich explained that the circumstance would be
rare. There are some circumstances where the reserves have
been sufficiently guaranteed, but it is not normal.
Senator Steadman questioned if downstream utilities have ever
financed a mega project without a firm transportation
commitment. Mr. Rich responded that there was a period (in
the lower 48 states) when it was normal for the utilities and
downstream users to be the parties contracting for
transportation services for smaller projects. None of them
were mega projects.
6:31:16 PM
Representative Coghill asked for more information regarding
the scope of other mega projects with a midstream force
majeure. Mr. Rich could not speak to current events. He noted
that concerns during force majeure contracts are curtailment
and interruption from uninsured events, environmental and
permitting problems, and technical and operating
difficulties: anything that could result in the pipeline not
being in a position to except volume from the upstream.
Representative Coghill surmised that they would look at the
track record and credit worthiness. Mr. Rich noted that
operating reputation, track record and capability of the
midstream operators make a large difference since the
midstream lenders are not covered by the firm transportation
commitments. All project financing bets on the sponsors
(project shareholders and promoters.) The technical
reputation and track record of the developers is considered a
risk mitigant.
Representative Coghil spoke to international issues. Mr. Rich
observed that firm transportation commitments are very
commercially sensitive and confidential, and are heavily
negotiated. The contract has the effect of having the lenders
bear the risk. Operating agreements will work hard to make
sure the pipeline entity is engaged in superior expertise.
6:38:12 PM
Representative Samuels spoke to the firm transportation
contracts, which are written between the shipping companies
and the midstream companies. Mr. Rich noted that guarantees
are critical. There is a tension with commerciality.
Everything is a trade off. Without Dual project risk, the
shipper, utility or producer is in a commercial agreement and
is not part of the financing process.
6:41:08 PM
Mr. Rich reviewed page 56, cross boarder pipelines. Cross
board pipelines create interesting structural issues.
Alliance had two separate partnerships, each borrowed their
own money, but both are dependent on the other. Lenders
reintegrated the Canada and U.S. portions. Lenders don't care
that it crosses a border. Lenders consider the financial risk
for the entire project. Single financing is preferred since
separation would add to the level of complexity.
6:43:18 PM
Mr. Rich discussed slide 57, the 10 largest oil and gas
pipeline project financings. The Alliance Pipeline Project is
the largest at $2.59 billion of debt on a $3.73 billion
project. Project shareholders are a mix of upstream merchants
and developers. The slide shows that some shareholder groups
are dominated by upstream oil companies. The #10 project
contained $480 million in debt. The big projects have been
entirely out of the U.S., with the exception of Alliance and
the Kern River Expansion.
6:44:52 PM
Co-Chair Chenault noted that the project is a mega project.
Senator Huggins referred to the world market and its affect
on procurement issues. Mr. Rich noted that the number of mega
projects around the world has created stress on resources,
especially the steel industry.
6:47:00 PM
Representative Coghill noted that mega projects create their
own economy. He asked if the focus is narrow. Mr. Rich noted
that banks are always looking at opportunities to make money.
Banks look at soft factors including strategic and economic
fundamentals. However, they also look at the benefit of the
project to the local economy and the support and
sustainability of the project.
Representative Coghill observed that once a project is
formulated a value can be attached, but questioned if there
is value from pre-completion. Mr. Rich explained that there
must be a bottom line of cash flow available for debt
service.
6:49:38 PM
Senator Elton asked if it is fair to look at the debt ratio
and conclude that lenders typically define "skin in the game"
as between 50 - 65 percent. Mr. Rich stressed that lender
expectations are driven by what is possible. He noted that
people do project financing for a variety of factors. Normal
leverage varies by country and market. He agreed that from a
pure "skin in the game" perspective, 30 percent is okay, but
added that the more, the better. More equity can make the
difference in difficult projects.
6:51:52 PM
In response to a question by Senator Thomas, Mr. Rich noted
that the first financing for the Canadian Alliance Pipeline
project was in the early to mid 90's. It was quite successful
and had multiple refinancing. Senator Thomas noted that the
Alaskan pipeline would be 10 times the cost. He questioned if
Alaska is dreaming too big. Mr. Rich was not in a position to
comment. He conceded that it is the most ambitious and
challenging project that he has encountered. He felt that the
project would doable with the right legal framework.
Senator Thomas questioned where the money came from on the
top 10 projects. Mr. Rich observed that the money came from a
variety of areas and that it is a completely global market,
which is dominated by non U.S. banks. It is impossible to
predict where the money would come from [in terms of an
Alaska gas pipeline project], but he did not think that it
would be exclusively from U.S. banks.
6:56:40 PM
Senator Therriault noted that the FT commitments are heavily
negotiated. Mr. Rich stressed that open seasons are different
and it is hard to predict when it would occur, but emphasized
that lenders would not simply accept contracts put in front
of them.
In response to a question by Senator Thomas, Mr. Rich did not
know of an expiration date for federal loan guarantees.
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