Main Project Finance Mechanisms In The Upstream Oil & Gas Industry And The Risk And Project Life Cycle Effects Of Using Venture Capital Finance

Main Project Finance Mechanisms In The Upstream Oil & Gas Industry, Risk And Project Life Cycle Effects Of Using Venture Capital FinanceTOPIC:Presentation By: John K. Arthur Theophilus TawiaPresentation OutlineIntroductionUpstream Oil & Gas IndustryProject Finance MechanismProject Life Cycle in Oil & Gas IndustryVenture Capital FinanceRiskConclusionReferencesINTRODUCTIONThe Oil and Gas industry continues to face new challenges in the search and development of new productionThe upstream Oil and Gas industry is very capital intensive ventureWorkforce diversityRisky operations and InvestmentHigh rewardsUPSTREAM OIL & GAS INDUSTRYExploration & AppraisalBeginning of cycleDiscover the oil and / or gas; ascertain commercialityInvolves seismic data acquisition, exploration and appraisal well drilling

UPSTREAM OIL & GAS INDUSTRY (CONT.)Development and ProductionComprises field development planning; development activities and full scale production to surface

PROJECT FINANCE MECHANISMWhat is Project Finance?Project finance involves:The creation of a legally independent project companyFinanced withNon-recourse debtEquity from one or more sponsoring firmsFor the purpose of financing an investment in a single purpose capital asset.Usually with a limited life

PROJECT FINANCE MECHANISM (CONT.)Why Project Finance?1) To minimise the net cost associated with market imperfections such as Taxes Incentives conflictsFinancial distressTransaction cost

2) To manage risk more effectively and more efficiently

PROJECT FINANCE MECHANISM (CONT.)Partners InvolvedSponsors and investors involved in the construction and management of the project.Lenders needed finance is generally raised in the form of debt from a syndicate of lenders such as banks.Government project company needs to obtain a concession from the host government.

PROJECT FINANCE MECHANISM (CONT.)Partners InvolvedSuppliers and Contractors role of turnkey contract to make sure that construction is completed within cost and on schedule.

Customers depending on the contract, multiple or single contractor.

PROJECT FINANCE MECHANISM (CONT.)Common Features of Project FinanceCapital IntensiveHighly Leverage (15 20 years)Independent Entity with a finite LifeNon-recourse or Limited Recourse FinancingControlled Dividend PolicyMany ParticipantsAllocated RiskFavourable Task TreatmentSpecial Purpose VehiclePROJECT LIFE CYCLEThe Key Stages of a Project Life (Petroleum Operations) are:Explore: to find it in the first placeDevelop: the infrastructure to get it outProduce: the petroleum you have foundAbandoned: when it runs out and cleanup (decommission)VENTURE CAPITAL FINANCEThis is a long term fund in equity to finance hi-tech project (Upstream Oil & Gas)It involves high degree of riskVenture capitalist earns his returns from capital gainsThe objectives is to earn a high rate of returnsVENTURE CAPITAL FINANCE (CONT.)Characteristics FeaturesInvestments are made in equity in hi-tech industry and waits for 5-7 years to recap the benefit of capital gains.Investors do not interfere in day-to-day business affairs but closely watches the business unit.The claim over the management is decided on the basis of proportion to investment.RISKWhat is a risk?The chance of lostDangerous elementExpose to danger

The analytic task begins with a broad spectrum of risks to which lenders might be exposed.Determining which risks the project can avoid through allocation of those risks elsewhereTHREE MAJOR RISKS IN UPSTREAM OIL & GAS INDUSTRYCommercial Risk: Completion risksOperating risksRevenue risksInput supply risksForce Majeure risksSponsor Support Risk

THREE MAJOR RISKS IN UPSTREAM OIL & GAS INDUSTRY (CONT.)Financial Risk: Exchange RateInterest RateOther Market Risk not directly related to the project

THREE MAJOR RISKS IN UPSTREAM OIL & GAS INDUSTRY (CONT.)Political Risk: Role of expropriation, currency convertibility and transferability, political violence (war, sabotage and terrorism).Risk of unanticipated changes in regulations or failure by the government to implement tariff adjustment because of political consideration.

ALTERNATIVES SOURCES OF RISK MITIGATIONRISKSOLUTIONCompletion riskContractual guarantees from manufactures, selective vendors of repute.Price riskHedging Resource riskKeeping adequate cushion in assessmentOperating riskMaking provision, insuranceEnvironmental riskInsurance Technology riskExpert evaluation and retention accountsCONCLUSIONThis type of funding is not right for everyone. Those companies who have high growth potential such as Oil and Gas and other hi-tech ventures are the ones who fare best with venture capital funding.Project finance, as an organisational risk management tool, reduces the potential collateral damage that a high risk project can impose on a sponsoring firm, i.e risk contamination. It also reduces the costs of financial distress and solves a potential under investment problem.REFERENCESAmit, A.R., J. Brander, and C. Zott (1998). Why do venture capital firms exist? Theory and Canadian evidence, Journal of Business Venturing 13, 441-466.Bascha, A., and U. Walz (2001a). Convertible securities and optimal exit decisions in venture capital finance, Journal of Corporate Finance 7, 285-306.Black, B.S., and R.J. Gilson (1998). Venture capital and the structure of capital markets: banks versus stock markets, Journal of Financial Economics 47, 243-277.Casamatta, C., and C. Haritchabalet (2003). Learning and syndication in venture capital investments, Working paper 3876. CEPR.

REFERENCES (CONT.)Rajan, R.G., and L. Zingales (1995). What do we know about capital structure? Some evidence from international data, Journal of Finance 50, 1421-1460.

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