Project Finance

Topics: Finance, Debt, Risk Pages: 5 (1543 words) Published: March 7, 2011
1. How should PDVSA finance the development of the Orinoco Basin? Can you define project finance? Is Petrozuata a project? What are the costs and benefits of using project finance instead of the traditional (debt) finance – as Mr. Bustillos said, PDVSA could have finance the debt internally (p.7 of the case)?

Project finance is a kind of Financing that has a priority does not depend on the creditworthiness of the sponsors proposing the business idea to launch the project. Approval does not even depend on the value of assets sponsors are willing to make available as collateral. Instead, it is basically a function of the project’s ability to repay the debt contracted and remunerate capital invested at a rate consistent with the degree of risk inherent in the venture concerned.

We deem Petrozuata as a project for it will be a totally standalone entity and the ability of repayment and financing risks are mainly associated with the entity.

According to a huge body of literature, we summarize the main difference between project financing and the traditional finance as followings.

One major disadvantages of project financing is that structuring and organizing such a deal is actually more costly than the other option. According to some evidence available on the subject shows an average transaction costs on the total investment of around 5–10%. The reasons for this can be listed as followings: 1. The legal, technical, and insurance advisors of the sponsors and the loan arranger need a great deal of time to evaluate the project and negotiate the contract terms to be included in the documentation. 2. The cost of monitoring the project in process is very high. 3. Lenders are expected to pay significant costs in exchange for taking on greater risks.

On the other hand, there are many benefits as compared to Debt. 1. Project Finance allows for a high level of risk allocation among participants in the transaction. 2. From the accounting side, contracts between sponsors and the standalone entity are essentially comparable to commercial guarantees. 3. Corporate-based Financing can always count on guarantees constituted by assets of the sponsor, which are different from those used for the investment project. In project Finance deals, the only collateral of the loan refers to assets that serve to carry out the initiative; the result benefit sponsors since their assets can be used as collateral in case further funding is needed. 4. It helps to make it possible to isolate the sponsors almost completely from the project.

With knowledge of the pros/cons listed above, we recommend to use project financing for reasons: •Project finance holds less risk for the participants in the joint venture (entity) than simply financing it themselves •Protects the participants from bankruptcy risks because they have limited responsibility. The project is regarded as legally independent and equity returns are increased and the companies’ own debt capacity isn’t used up.

2. What are the risks associated with Petrozuata’s (e.g., pre-completion and post-completion project risks, country risks, etc)? Among the list of various types of risks, which ones are the most significant? How does the proposed deal structure address and alleviate these risks? Who should bear these risks if the project were financed entirely by PDVSA instead?

There are mainly three types of risks associated with the project. •Pre-completion risk
Planning risk. Bad planning may lead to chaos and defer or hinder the operation phase during which the project is supposed to generate cash flows. Also delays in completing one activity can have major bad effect on subsequent activities. –Completion risk. The project may not be completed or that construction might be delayed in form of •Non-completion or delayed completion due to force majeure •Completion with cost overruns

Delayed completion
Completion with performance deficiency
Post-completion risk...
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