Project finance for the oil and gas industry
Oil and gas industry financing refers to a method of financing a business that relies on using the future cash flows generated by a specific project to service debt.
This financing technique is characterized by certain parameters that are important for participants to consider in order to develop an optimal financial model.
In general, project finance is applicable to large investment projects, including international projects in the oil and gas industry, which usually cost tens of millions of euros.
Large investments in the oil and gas sector require the mobilization of capital at all levels, including financing from commercial banks, investment funds, government agencies, and so on. Insufficient investment in the extraction and transportation of energy resources can lead to fuel shortages, rising prices and a slowdown in the global economy.
Project finance (PF) instruments, which flourished in the 20th century in the oil and gas sector, today offer ample opportunities for the implementation of ambitious projects, including the development of hard-to-reach hydrocarbon deposits and the expansion of LNG transportation networks.
These financial instruments were first used to develop oil fields in Texas and Oklahoma in the 1930s, and subsequently PF was successfully used to increase oil production in the North Sea shelf and other oil and gas projects around the world.
Today project finance is of interest not only to businesses, but also to governments, as the energy sector becomes more and more politically important in the context of energy independence.
Regardless of the sources of oil and gas industry financing, success directly depends on the correct assessment and preparation of the project and the choice of the most appropriate financing model.
In this sense, participants can use a wide range of financial instruments and techniques that determine the attractiveness of a particular project and future investment opportunities.
Capital budgeting plays an important role at this stage, which requires professional cost analysis, cash flow forecasting and financial resource costing from project participants. Once a financial decision has been made, attracting stable financial flows for the long term begins to play a critical role in maintaining the specific project.
This activity includes discussion and selection of project alternatives, financial alternatives, and planning of each of the project aspects.
Project finance participants in oil and gas industry
The structure and participants of project finance schemes reflect the needs of all stakeholders for reliable and sustainable financing, taking into account risk minimization.
Understanding this structure is critical to the success of capital-intensive projects under high uncertainty.
This scheme usually involves one large lender or a group of several lenders who negotiate with the project proponents with the participation of a wide range of external parties, including independent consultants, engineering companies and even government bodies. This is due to the need for professional evaluation, monitoring and control of the project at different stages.
More about participants in the oil and gas industry financing are seen below.
Borrower: In project finance, the borrower is an SPV / SPE, a company with separate assets that raises significant funds without risk to originators. This company is liable for project debts with its assets, which are usually the facility under construction and its infrastructure.
Project sponsors: These are the participants directly responsible for project management, negotiating with capital providers and other activities. Sponsors (for example, petroleum companies or LNG suppliers) form a separate project company of the appropriate structure, which attracts funding and assumes project risks.
Capital providers: The list of capital suppliers (lenders) for modern oil and gas projects is quite wide. All of them rely on an adequate return of capital at an acceptable risk, which largely depends on the specific project and its structure. When it comes to strategic projects (for example, LNG supply), government structures can act as capital providers, which further strengthens the role of project finance.
Other parties: As mentioned above, PF schemes are quite complex and require the involvement of numerous intermediaries, independent experts and firms to provide the necessary engineering, legal, financial and other support. The right choice of partners and their inclusion in the optimal contract structure is one of the key conditions for the successful implementation of projects.
Functions of a project finance advisor
Professional project finance advisors can offer a range of useful services to ensure smooth capital raising and oil and gas project management. We are accustomed to considering an adviser only as a consultant, however, in modern realities, experienced specialists can help clients in negotiating, developing financial models, searching for counterparties and even attracting government bodies to work on a particular project.
The project finance advisor can perform the following tasks:
• Conducting a feasibility study.
• Development of a financial model and project structure.
• Drawing up a balance sheet and debt repayment schedule.
• Negotiating with suppliers and contractors.
• Finding and hiring professional consultants.
• Coordination and preparation of financial proposals.
• Preparation of project documentation, etc.
The services listed above may be provided by private consulting firms, large banks and other financial institutions.
When choosing a specific adviser, it is important to take into account such factors as experience, reputation, area of specialization, potential conflicts of interest, cost of services, etc. Contrary to the opinion of many managers, a project finance adviser is a very important figure, which largely determines the correctness of investment decisions.
Stages of project finance in oil and gas sector
The stages of project finance for most sectors are similar as funding is sourced and provided through the same mechanisms based on the future cash flows of a particular project.
Whether it is an upstream project or the construction of an LNG terminal, the project rationale and profit forecast will play a key role in the decision of the lenders, but not the assets of the initiators.
On the other hand, each investment project is unique, therefore, in each case, the practical approach to its financing should be adapted to the needs and interests of the parties.
Oil and gas industry financing in each case require a customized approach, depending on the specific market, industry and other factors.
Any projects in the real world face unforeseen circumstances that require a certain “margin of safety” in their financial and technical structure. The correct setting of PF mechanisms allows the business to ensure the achievement of strategic goals at minimal cost.
Oil and gas project finance documentation
Since project finance differs from other financing schemes in its complex and multifaceted contractual structure, the preparation of a transaction requires a serious effort from all parties.
Each of the agreements within the framework of a particular project performs its function in close connection with other project documents. Accordingly, each document must be legally perfect, fully meeting the needs of the project in a certain time horizon.
In order to visualize the project and evaluate it, specialists widely use spreadsheets, as well as advanced computer modeling methods. It is important for potential lenders to make the project as clear as possible before making a decision, as PF schemes are based on future cash flows and are considered quite risky for capital providers.
Experts distinguish two groups of project finance documents in relation to the oil and gas sector, which are formed in close cooperation with different parties:
• Project documentation. This type of documentation includes drawings, calculations, and agreements made with so-called “non-funding” project participants. This includes engineering companies, equipment suppliers, construction companies, etc.
• Financial documents. This broad group includes loan agreements, insurance agreements, bank guarantees and other documents that are directly related to the financing of a particular project.
A comprehensive project agreement structure is being created with the main goal of ensuring understandable and transparent rights and obligations of all participants, as well as establishing procedures for dealing with project failure or underachievement of planned indicators.
For this reason, a number of financial, engineering and commercial documents must be developed over a long time horizon, typically exceeding 15 years for oil and gas projects.
However, the documentation should be flexible enough to allow the parties to adapt to changing circumstances.
Our experts are ready to assist your team at any stage of the project.
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