Introduction
This page includes background for project finance analysis and theory courses. The project finance theory includes the essence of project finance, selected case studies, debt financing structure and the theory of debt contracts. I begin courses by discussing what is finance — something I was never taught in business school classes. I suggest that finance is about making an investment. An investment could be a buying a stock; it could be buying a whole company as part of an acquisition program; it could be making capital expenditure for a factory; it could also be the time taken to go to the heath club; it could be the cost and time taken to go to the dentist to have your teath cleaned; it could be the opportunity cost and out of pocke cost of getting an education; it could be the gambling. For each of these investments, you have to wait to get the benefits. If you have to wait, the benefit of an investment is uncertain. You do not know whether the stock will increase and pay you dividends; you do not know if your excerise make you healthier and/or more beautiful; you do not know with certainty whether the capital expenditure will produce more money that you paid for it and you need to do some kind of cost benefit analysis to evaluate whether the investment is a good one.
The idea of finance is to perform such a cost and benefit analysis. This cost and benefit comparison can also be termed the rate of return. The problem in finance and with so many decisions in your life is that when considering the future benefits that by definition have some associated uncertainty, you need to make some kind of assessment of the risk associated with realising the benefits. This is what finance is about. It is about why London has such a good public transporation system while you could not image life without a car in Silicon Valley. It is about wondering how people constructed incredible catheridials while we now build data centers. Somebody had to make a whole lot of assessment of the cost and benefits of investments.
A theme of the project finance course is that project finance is much more than just another kind of debt. I suggest the debt financing of the project defines the value of the project and the cost of capital for an investment which is a cost and benefit technique for really important long-term investments. Project finance deals with difficult issues of cost of capital and risk measurement in a unique way. As with other pages, this webpage includes a number of files attached to different buttons which include PowerPoint slides and a number of excel files that are used to demonstrate various theoretical issues. The initial section covers the difference between project finance and corporate finance, arguing that project finance should be the foundation of much of the study of finance. The course then moves to four mini-case studies that are designed to demonstrate the structure, contracts, economic analysis and other issues associated with project finance. I have tried to select historic case studies that were spectacular successes or failures. In the subsequent section I move to contract analysis, including the loan agreement. Finally, I discuss the upsides in project that arise from reduction in risk.
Project finance can involve important public policy issues where capital intensive assets my need goverment support to promote an industry. When public policy issues are combined with project finance, investments can be encouraged along with providing incentives for owners to act in an innovative manner.
Advanced Project Finance
The idea of this course is to address more advanced issues of risk analysis, government policy, financial structuring and contract analysis surrounding project finance. The course designed with financial modelling, detailed contract analysis, evaluation of nuances in project finance statistics and risk analysis. The button below includes the power point slides that work through issues in the case. The power point slides discuss various nuanced issues related to evaluation of risk and return alternatives to IRR, DSCR, re-financing, liquidated damages, financial structuring and credit support. It may be helpful for participants in the course to review slides for the foundations course as well.
.
.
Quiz Questions
- What is the ultimate measure of risk for a project finance loan
- What is the best measure of the ultimate risk of a loan
- Does the IRR give more weight to near term cash flows
- With and IRR of 12% what is the difference between doubling the cash flow after year 40
.
.
Project Finance Power Point Slides and Outline
.
Case Study of Blackburn Hospital with Unitary Payment, Performance Adjustments and Investor Analysis
.
.
Analysis of Spanish Merchant Prices over Time with Renewable Energy and Negative Prices
.
.
Financial Analysis of Different Companies (Investors and O&M Companies) participating in PPP/PFI
.
Pre-Course Reading and Pre-Course Videos
.
As part of my new book on re-thinking finance I have a section devoted to project finance. A couple of the introductory chapters to explaining project finance and the foundations of investment and financial analysis are presented below along with a video that summarises the chapters.
.
.
.
.
Files for Analysis of IRR and DSCR
Discussion of more detailed issues including how and why to use the IRR and DSCR are discussed in the second excerpt attached to the button below.
.
.
Case on Debt Structuring Number 1 - Exercise on Monte Carlo where some of the data is filled
.
.
Financial Model Excel Files for Advanced Project Finance Course
.
In the advanced project finance course I refer to some financial modelling files to demonstrate the nuanced risk and return, contract and public policy issues. The files are designed so that partipants can focus on nuanced issues of measuring return with alternatives to IRR and risk with LLCR, PLCR and probability of default. There where will be a some practice excel formulas but the models will be primarily related to thinking about analysis — debt structuring, credit risk analysis and understanding the perspective of equity investors.
The first three files below are excel files with some excel exercises designed to allow you to understand the nucances of IRR (as the growth rate of cash flow) and debt structuring to illustrate the skeleton of any project finance analysis, nuances of DSCR, LLCR and PLCR and application of cash sweeps in a cash flow waterfall. In the first model you create a basic financial analysis to compute project IRR and equity IRR. This file is used to illustrate various ideas related to measuring risk and return and issues such as the project IRR versus the equity IRR. It is also used to demonstrate debt sizing and debt structuring issues. In the second file more advanced issues are discussed including illustrating the mean reversion and volatlity and their relationship with DSCR, LLCR and PLCR.
.
.
.
.
In addition to the excel file used to work through mechanical issues assoicated with project finance, I have included financial models that are used to quantify nuances of the policy, and risk issues associated selected cases. The first case study is the same as the case for the foundations course, but the case is used to evaluate different issues including problems with measuring risk and return. The first modelling case study file with financial models uses a model of the Petrozuata project in Venezuela. My notes on these cases are discussed in the power point slides.
.
.
The second case for the advanced course addresses issues with development costs, corporate financing versus project financing of off-shore wind projects, details of financial structring and, not least political risk issues. I have included a fairly detailes financial model of an off-shore wind project to demonstrate the effects of debt structuring when different constraints are in place. This is the case of Orsted in Denmark which faced dramatic risks when investing in off-shore wind projects in the U.S. The case questions how to achieve verification of risks from lenders and other renewable energy issues.
.
.
The the final case discussed in the Foundations course is for the famous Eurotunnel project. The case prompts questions of what kind of risks should be supported by the government in favour of encouraging public policy (like taking the train) and what kind of risks should be taken by private sponsors. As with the other cases, you are encouraged to ask what could have been done differently with hindsight to avoid the problems that occured. These issues involved question of contract structures (the construction contract), the ownership structure and allocation of traffic risk.
.
.
Back-up Files for Discussion of Case Studies for Advanced Course
.
The files below include some back-up for the case studies. These files include data for the production of wind for Orsted projects; a Standard and Poor’s write-up of the Ras Laffan project; Excel files for the Dahbol project and the initial offering memorandum for the Eurotunnel project. This file is used to introduce the Ras Laffan case with analysis of commodity prices. You are supposed to look for volatility and mean reversion in the prices and make a judgement as to what is acceptable.
.
.
.
This file contains the pre-sale report for Ras Laffan which was used as a credit write-up and discussed the risks of the project. The idea of this report is just to skim through the discussion of risks and look at the presentation of the financial model.
.
.
This file is the financial model for Ras Laffan with alternative oil prices. You are to use this file to evaluate the cost structure of the project and to compute the break-even oil prices by yourself. When you compute the break-even price, you need to subtract the transport cost to derive the cost realized by the project. In formula terms: Worldwide Gas – Transport Cost = Gas to Project. This can be computed with a simple oil to gas ratio of about 6 bbl per MMBTU. This means if the oil price is 60 then the gas price is 10. If the trasport cost is 3 then the net gas to Ras Laffan is 7.
.
.
The button below is for the Dahbol case. You are to compute a couple of IRRs and use the data to evaluate the key risk of the project which could not be easily mitiagated. This excel file comes straight from the HBS case study where provision of the contracts were published.
.
Excel File with Data from the HBS Dabhol Electricity Plant Case with PPA and Capital Costs
.
The file below has the exercise for Eurotunnel. You can evaluate the construction risk and the traffic risk, both of which were not properly mitigated and both of which were difficult to accept in project finance.
.
.
The file below has the initial offering memo for Eurotunnel which describes the construction contracts and the traffic projections. The file is ancient from the 1980’s but you can see some of the ideas that we would now think are crazy. The ideas include taking traffic risk, having the EPC contractor own a majority of the project during the signing of the contracts, having an IPO structure …
.
Offering Memo for Initial Public Stock Offering of Eurotunnel Project before Financial Close
.
The file below is back-up data in an excel file for Orsted. This file was only availble after the large write-off for the Ocean Wind project. Before the write-off it was not possible to see detailed data on a project by project basis. There is still limited data on the performance of individual projects.
.
.
Term Sheets, Contracts and Credit Write-ups used in Discussion of Advanced Project Finance Course
.
The file attached to the button below is a file that illustrates different financial issues that are used in the remainder of the course. The file attached to the first button is an example term sheet. If you work through the document and understand the language it would be a good thing to do.
.
PDF File with Term Sheet for Loan Agreement that Illustrates Various Financial Structuring Items
.
The file attached to the button below is an example of how lenders assess risks of a project. The file attached to the button below is meant to demonatrate how lenders can have more background on a project than developers because of the history of how they assess projects. They have databases, experience with other projects, they hire experts, they have consistent ways to evaluate risk and so forth ..
.
Example of Analysis of Solar Project with Independent Engineer and Sensitivity Analysis
.
Once the ideas of risk allocation to encourage efficiency and social objectives are established, contracts apply the ideas. To discuss how the objectives translate to contract language, actual contracts are reviewed. The discussion of contrat structure uses examples of contracts that are public or disguised. The button attached to the PPA contract below has both and output based contract and a capacity based contract in the context of a battery plus solar project. The contracts raise risk allocation issues.
.
.
.
The file attached to the button below may not seem to have too much to do with project finance. It is my general file on downloading stock prices and includes the IRR’s, volatility and betas for many stocks. I use the file to discuss general issues about IRR and growth and also how dividends come into play in the calculaiton of IRR using adjusted stock prices.
.
Excel File that Uploads Stock Price Data from Finance.Yahoo Economic Data from FRED using Python
.
.
Monte Carlo Simulation, Risk, Mean Reversion and DSCR
The first exercise demonstrates risk issues with volatility and mean reversion. The idea is to show how project finance is about managing risk over long-term periods. You can use the probability of default with the DSCR and the probability of loss with the PLCR. You can see the probability of default and probability of loss with different DSCR Ratios. The idea of this file is to enter different levels of volatility and mean reversion and then determine what DSCR will result in a reasonable probability of default and probability of loss. You can look at the macros in the file that are used to create a Monte Carlo simulation.
.
.
The file below is an excel file that reconciles project finance with corporate finance.
.
Excel File with Projects Consolidating to Portfolio Demonstrating Returns and Financial Ratios
.