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Gas Project Financing: What Lenders Evaluate Before Committing [Oil and Gas]

Oil and Gas, Project Finance, Financial Markets, Investment, Foreign Investment, Funding, Law, Energy.

Tope Adebayo LP.

Business, Law, Leadership, Entrepreneurship. Gas Project Financing: What Lenders Evaluate Before Committing [Oil and Gas]
Oyemaja; Gas Project Financing: What Lenders Evaluate Before Committing [Oil and Gas]

Gas projects typically involve significant expenses, this is why the project financing structure is usually leveraged. By comparison, utilizing corporate finance would necessitate each sponsor funding its portion of the project by utilizing a mix of their available capital and personal loans. This approach would constrain the ability of sponsors with lower credit ratings to secure higher levels of debt.

Under the project financing structure, the project sponsors provide equity and sometimes bring in other financiers to provide equity to cover project start-up or development expenses while generating large amounts of debt through banks and other lenders.

Project finance allows the project sponsors to maintain a corporate debt-to-equity ratio which is usually 70:30, the debt located off the sponsor's balance sheet, but on the balance sheet of the project company, i.e. the Special Purpose Vehicle (SPV).

The Project Financing Process

Debt to the project company is provided by a syndicate of lenders both private and public such as commercial banks, multi-lateral development banks, pension funds, investors in the public bond market, export credit agencies and government-backed lending institutions, who differ in terms of the amounts they lend, lending conditions as well as the ranking in the order of repayment. It is not uncommon to have over 20 banks lending to a gas project.

The debt is repaid from the project earnings. The loans are priced at a margin applied above the base rate, which is often the London interbank offered rate. The loan pricing or margin will depend on an assessment of the project's risk and on the cost of funding. The loan may however be repriced to take into account changing market conditions as will be agreed by the project company and lenders.

Because of the complexity, scope and the risks associated with gas projects, the project financing takes some time to arrange, usually between 2 years or more. The time taken will depend on a number of factors such as the project development process, project cost, associated risks of the project and host country, the number of financiers needed, external market conditions such as, fluctuation in foreign currency, amount of liquidity in financial markets etc. A wide range of advisors will be required throughout the financing process; from financial to commercial to legal to technical advisors.

The project company (SPV) is formed and will obtain its permits, and licenses, project agreements are then structured, negotiated, and executed by the project stakeholders, including the host government. Financing discussions start concurrently with the FEED studies and tenders from the Engineering and Procurement Contract (EPC) contractors.

FEED means the front-end engineering design, and this is done after the feasibility study to estimate the technical specifications, subsequent cost and procurement needed for a project. It comprises, thorough project scope, complete project budget, total cost of ownership, implementation timeline, and initial risk assessment. The gas project stakeholders and their advisors will hold initial talks with the banks known as ‘soundings’ in order to gauge their interest in participating in the project financing and to pinpoint any impediment to fundraising.

Oyemaja; Gas Project Financing: What Lenders Evaluate Before Committing [Oil and Gas]
Oyemaja; Gas Project Financing: What Lenders Evaluate Before Committing [Oil and Gas]

10 Key Considerations Before Lenders Commit to a Gas Project

Before the point of soundings, lenders will be involved in extensive due diligence exercises, this involves a careful analysis of the various risks associated with the project and the bankability of the project. The considerations by a lender whether or not to be involved with a gas project will typically include:

  • Host country laws: The general attitude and approach towards foreign-financed gas projects will be crucial in attracting foreign investment. If there has been any history of less than even-handed treatment of foreign investors or generally of changing the laws & rules, this may act as a serious block on the ability of lenders to finance gas projects.

  • Internal bank rating systems of the host country: Lenders are willing to find higher rating countries because of the risk cover provided, and the fact that they will have to apply less capital under the banking guidelines. However, the ratings of the host country will matter less to the lender if the gas project is being implemented by credit-worthy sponsors.

  • Contractual alignment/Business Model Underpinning Project: Lenders will ensure that the major project agreements have consistent provisions and do not contain any unintended contractual disconnects. Such agreements are construction, operation, and maintenance agreements, and off-take agreements. Of particular importance to the lenders are the offtake or tolling agreements. The project company must have contracted in advance with an identified off-taker, and these contracts need to be of sufficient duration to allow the debt to be serviced across long repayment horizons, with credit-worthy counterparties. The business model underpinning the gas project is also of significant importance to the lenders. Whether it is an integrated/non-integrated, merchant/tolling contract arrangement will determine the risk profile of the project.

  • Ability of EPC contractors and project sponsors to implement project: Having experienced EPC contractors is crucial. Lenders will ensure that the EPC contractors have sufficient technical & management resources to deliver & perform to the specifications of the project documents. They may go ahead to investigate whether these contractors have undertaken similar arrangements in the host country.

  • Creditworthiness of counterparties: Lenders will determine the creditworthiness of the parties and whether they have sufficient financial resources to meet their obligations under the relevant project documents. If the lenders are not so satisfied, then they are likely to call for guarantees or letters of credit from parent companies or other banks and financial institutions to support these obligations.

  • Project company’s permits & licenses: The project company’s permits and licenses must be adequate to construct, own & operate the gas project, and were obtained in compliance with all applicable laws and regulations. Project company must be duly authorized to enter contracts and carry out its obligations thereunder.

  • The Finance documents: This involves the project lenders and their respective counsel carefully reviewing and commenting on project company’s finance documents including the mortgage & security documents which cover all the project assets.

  • Environmental/social impact of project: When assessing the environmental and social impact of projects, many financial institutions use the risk management framework called ‘the Equator Principle’. This is done to avoid the project being a target for NGOs.

  • Insurers: In many instances, the absence of insurance coverage for a complete loss of a facility could result in sponsors and lenders facing complete losses themselves. Consequently, lenders, in particular, meticulously examine not just the extent of coverage but also the entities offering that coverage. Typically, lenders prefer insurance provided by prominent international insurance firms and may hesitate to accept policies from local insurers in developing nations.

  • Independence of project parties: It will sometimes be a concern for foreign lenders if the project parties are likely to be influenced by local political considerations in a way that might be detrimental to them.

To determine the above, the financial advisors produce an information memorandum and financing request proposal (FRP) which is filled by the project sponsors and sent back to the lenders. The FRP contains details needed by potential financiers to assess the project such as details of project, details of LNG offtake or tolling contracts encompassed in the sales and purchase agreements, details on project construction, EPC contract and timeline, plans for shipping, details of operation and maintenance, technologies to be applied, plans for environmental protection and remediation amongst others.

After due consideration of the project characteristics, its bankability, and the project risks, lenders who decide to go ahead with financing the project will approach their credit committees to get approval. Once a sufficient number of lenders have received credit approval, the financing agreement or term sheet can be signed, and the project will move to a financial close, and the drawing of the funds begins.

Before agreeing to lend to a gas project, the lenders will pay specific attention to each of the parties that will have an involvement (however small) in the project, whether at inception, during the construction phase or during the operating phase. It is not an exaggeration to say that, in the case of many gas project financings, the robustness of the overall project structure is only as strong as its weakest link.

Originally published by Sandra Osinachi-Nwandem on Linkedin

Oyemaja Law

Oyemaja Executives


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