Project Finance

Introduction

Origins of project financing

With the explosion of project financing in the late 1980s and 1990s, both in Europe and around the rest of the world, there is a temptation to think that the financing of projects on limited or non-recourse terms is a relatively novel concept, and one for which the ingenious lawyers and bankers of the 1980s can take most of the credit. This is, however, far from being true. Indeed, there is early evidence of project financing techniques being actively used during Roman times and earlier still. According to the historians, sea voyages on the Mediterranean ocean were extremely dangerous adventures in Greek and Roman times, mostly on account of the dual perils of storms and pirates. As a result of these nautical perils, some risk averse merchants would take out a fenus nauticum (sea loan) with a local lender in order to share with that lender the risk of a particular voyage. The fenus nauticum worked on the basis that the loan was advanced to the merchant for the purpose of purchasing goods on the outward voyage, which loan would be repayable out of the proceeds of the sale of these goods (or more likely other goods bought overseas with these proceeds). If the ship did not arrive safely at the home port with the cargo in question on board, then according to the terms of the fenus nauticum, the loan was not repayable. At the time, this was viewed essentially as a form of marine insurance, but it can just as easily be classified as an early form of limited recourse lending, with the lender assuming the risk of the high seas and the perils that accompanied her. History also recounts that, in order to protect their interests, these brave lenders would often send one of their slaves on the voyage to ensure that the merchant was not tempted to cheat on the lender (an early ancestor of the security trustee perhaps!).

In modern times too there is plenty of evidence of project financing techniques being used by lenders to finance projects around the world. In the 19th century, lenders in the City of London were financing numerous railway and other projects in South America and India and investing in other overseas ventures that had many features of modern-day limited recourse lending. In most cases these loans were not specifically structured as limited recourse loans as we know them today, but the commercial reality was that this is exactly what they were.

However, limited recourse lending in the UK really took off in the early 1970s when lenders in the UK started making project finance available for the development of some of the early oil and gas fields in the UK continental shelf. The early projects that were financed on this basis were relatively few and far between as there was a relatively small pool of lenders prepared to finance projects on this basis. It would also be true to say that the treasurers of many of the companies operating in the UK continental shelf at this time took some time to appreciate the advantages of financing projects in this way. The first major financing in the North Sea was in the early 1970s. This was British Petroleum’s Forties Field, which raised about £1 billion by way of a forward purchase agreement (see section 4.7 for a description of this structure). Shortly after this transaction two loans were raised by licence holders in the Piper Field (Occidental Petroleum Corporation and the International Thompson Organisation). Other financings of North Sea hydrocarbon assets followed and by the late 1970s and early 1980s what had started as a modest number of transactions had turned into a significant volume of project financings related to oil and gas fields, first in the UK continental shelf and then in the Danish and Norwegian continental shelves.

Much of the documentation and many of the techniques for these early oil and gas transactions were borrowed from practice in the US where adventurous bankers had been lending against oil and gas assets for many years. The significant difference in the context of the North Sea, however, was that bankers were in reality taking significantly more risks in lending against oil and gas assets in the North Sea. Not only were these brave bankers lending against offshore oil and gas assets where the risks were considerably greater (especially in the early days, given the new technology being developed and utilised), but they were also, in some cases, assuming all or part of the development/completion risk. Traditionally, in the early days of project financing in the US, loans were agreed against producing onshore assets, which carried a far lesser degree of risk. The North Sea was, however, an altogether more hostile and hazardous environment.

The 1980s in the UK saw perhaps the greatest growth spurt in project financing, with power projects, infrastructure projects, transportation projects and, at the end of that decade, telecommunications projects leading the way. This was continued throughout the 1990s until the more recent global financial crisis, which saw a huge growth in project financing, not only in Europe and the US but also throughout Southeast Asia and further afield.

Definition of project finance

There is no universally accepted definition of project finance. A typical definition of project financing might be: “The financing of the development or exploitation of a right, natural resource or other asset where the bulk of the financing is to be provided by way of debt and is to be repaid principally out of the assets being financed and their revenues.”

Other more sophisticated definitions are used for special purposes; set out at Fig. 1 is an example of a definition used in a corporate bond issue. This illustrates the aims of the bondholders, on the one hand, to exclude from the definition any borrowings having a recourse element (since the purpose of the definition was to exclude project finance borrowings from the bond’s cross-default and negative pledge) whilst, on the other hand, the aim of the issuer to catch as wide a range of project-related borrowings.